2/28Adjustable-Rate Mortgage (2/28ARM)
A mortgage plan that combines a short fixed-rate period with a much longer adjustable term.
2/28 Adjustable-Rate Mortgage Details
The 2/28 adjustable-rate mortgage product has its first two years of the mortgage at a fixed interest rate. After this, the loan will regularly adjust the interest rate based on the mortgage's stated index. Nowadays, borrowers with a challenged credit history or unverifiable income have issues securing approval for conventional mortgage products. As a result, they have to seek alternative funding, which is the subprime lending market. This option usually is more expensive than its traditional counterparts.
The 2/28 adjustable-rate mortgage is a popular type of subprime loan product with the first two years (teaser period) interest rate well below the market rate. This gives the borrowers a chance to improve their credit history and have the capability to refinance into an affordable fixed-rate mortgage once the teaser period is over. However, some homeowners who cannot secure a traditional mortgage's approval face a significant jump in payment. And most of the 2/28 adjustable-rate mortgages have prepayment penalties written into their policy, making it expensive for homeowners to get into a more affordable product.
Example of 2/28 Adjustable-Rate Mortgage
For example, let's consider a 2/28 mortgage for $200,000 with a starting interest rate of 7.5%. It will have a cap on the first adjustment and a 1% cap on each additional adjustment. That means that the minimum interest rate equal to the start rate and a maximum lifetime rate of 13.5%. Also, the index and margin are 5.34% and 3%, respectively.
The 2/28 adjustable mortgage is often a subprime mortgage that generally has higher rates and a prepayment penalty, depending on where you live. The number "2" refers to the number of years that the loan will be fixed, and the number "28" refers to the number of years that the loan is adjustable after the fixed period. Therefore, a 2/28 adjustable mortgage due in thirty (30) years, and they may adjust every six (6) months after the initial fixed period expires.
Significance of 2/28 Adjustable-Rate Mortgage
Generally, the 2/28 adjustable-rate mortgage has interest rates far below the market price for the first two years. This is an excellent advantage to borrowers who might not qualify for a higher fixed-rate loan due to bad credit history or a low income but can still get their purchase or refinance money.
After the initial fixed period, say between 2 to 3 years as stipulated in their policy. The interest rate will become variable, and this sharp rate increase will put financial stress on the borrower who may be unable to sell or refinance their way into relief. Therefore, it's a double-edged sword. Many of the 2/28 adjustable–rate mortgages have a prepayment penalty that stipulates the payment of interest to the bank if the loan is paid off early. These clauses may not be stated clearly during the loan origination or within the loan documents or expressed verbally.
The adjustable-rate mortgage rates are not controlled by the bank but are pegged by the publicly published mortgage market indexes such as LOBOR, MTA, or COFI. Therefore, the borrower is at the mercy of the market forces.