We are fairly new to ARMS and I am trying to understand what a discount feature is according to 1026.19(b)(2). If our variable rate program has a fixed initial rate for five years not tied to an index, would this be considered a discount?

It's a discounted rate if the initial rate is less than the index plus margin when the loan is closed; it's a premium rate if the initial rate is higher than the index plus margin when the loan is closed.

If the index is 1.25% and the margin is 2.75%, the rate would be 4.00%, absent of anything else.

If your initial rate is less than 4.00% (example 3.5% for the first 5 years), you have a discounted rate
If your initial rate is greater than 4.00% (example 4.5% for the first 5 years), you have a premium rate

In today's rate environment it is important to monitor the initial rate vs the index plus margin at the time of closing. Especially if you set the beginning rate at the time you receive the application.

I recently had one that when the account opened the index used to set the initial rate was 1.14%. However, the 1.14% index was outside our 45 day lookback period. Going back 45 days the index was 1.15% That 0.01% on a this particular 3/1 ARM caused the finance charge to be understated by over $2,000. If I had not taken advantage of our 45 day lookback period and used the index at the time of closing the finance charge would have been understated by over $17,000. The understatement was caused due to the loan's payment streams were not properly disclosed.

Dan - And all that also depends on whether there is a written rate lock agreement or not when the initial rate is set. Otherwise, the rate is floating until closing and you have to use the index at consummation without the benefit of a 45-day lookback.