Final answer:
An adjustable-rate mortgage (ARM) is a type of loan where the interest rate varies with market interest rates. The maximum rate this borrower will ever see is 9.5% due to the caps on the ARM. The starting rate of 3.5% and the margin of 4% are added to the index rate based on the LIBOR to determine the interest rate.
Step-by-step explanation:
An adjustable-rate mortgage (ARM) is a type of loan where the interest rate varies with market interest rates. In this case, the borrower has a 7/1 ARM with 2/1/6 caps and a start rate of 3.5%. The caps indicate the maximum limit on how much the interest rate can change over time. The first number '2' refers to the maximum increase allowed after the initial 7 years, the second number '1' refers to the maximum increase allowed annually thereafter, and the last number '6' refers to the lifetime cap, meaning the maximum increase over the life of the loan.
The margin of 4% is added to the index rate, which in this case is based on the LIBOR. To calculate the maximum rate the borrower will ever see, we need to consider the caps and the starting rate. Let's assume the current index rate is 2.5%. After the initial 7 years, the interest rate can increase up to 5.5% (3.5% starting rate + 2% cap increase). After that, the annual cap allows for a maximum increase of 1% per year, so in year 8 it can reach 6.5%, in year 9 it can reach 7.5%, and so on. The lifetime cap of 6% ensures that the rate cannot exceed 9.5%. Therefore, the maximum rate this borrower will ever see is 9.5%.