What is a 2/28 ARM

A very common mortgage in the subprime market, which I have never seen outside of that market, is the 2/28 ARM. This is an adjustable rate mortgage on which the rate is fixed for 2 years, and then reset to equal the value of a rate index at that time, plus a margin. Because the margins are high, the rate on most 2/28s will often rise sharply at the 2-year mark, even if market rates do not change during the period.

For example, the rate is 8% for 2 years but the index is currently 4% and the margin is 6%. If the index remains at 4% after 2 years, the loan rate will jump to 10%.

Some borrowers with poor credit scores take a 2/28 at a high rate and plan to rebuild their credit during the 2-year period. Their plan is to refinance at a better rate at that time. The major threat to such a plan is a prepayment penalty that runs past two years, which some do; and a lender who fails to report their payment history to the credit reporting agencies. Borrowers should be on their guard against both.

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