Adjustable
Rate Mortgages
These loans generally
begin with an interest rate that is 2-3 percent below a comparable
fixed rate mortgage, and could allow you to buy a more expensive
home.
However, the interest
rate changes at specified intervals (for example, every year)
depending on changing market conditions; if interest rates go up,
your monthly mortgage payment will go up, too. However, if rates
go down, your mortgage payment will drop also.
There are also
mortgages that combine aspects of fixed and adjustable rate
mortgages - starting at a low fixed-rate for three to ten years,
for example, then adjusting to market conditions. Ask your
mortgage professional about these and other special kinds of
mortgages that fit your specific financial situation
Most adjustable rate
loans (ARMs) have a low introductory rate or start rate, some
times as much as 5.0% below the current market rate of a fixed
loan. This start rate is usually good from 1 month to as long as
10 years. As a rule the lower the start rate the shorter the time
before the loan makes its first adjustment.
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Index - The
index of an ARM is the financial instrument that the loan is
"tied" to, or adjusted to. The most common indices, or, indexes
are the 1-Year Treasury Security, LIBOR (London Interbank
Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and
the 11th District Cost of Funds (COFI). Each of these indices
move up or down based on conditions of the financial markets.
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Margin - The
margin is one of the most important aspects of ARMs because it
is added to the index to determine the interest rate that you
pay. The margin added to the index is known as the fully indexed
rate. As an example if the current index value is 5.50% and your
loan has a margin of 2.5%, your fully indexed rate is 8.00%.
Margins on loans range from 1.75% to 3.5% depending on the index
and the amount financed in relation to the property value.
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Interim Caps
- All adjustable rate loans carry interim caps. Many ARMs have
interest rate caps of six-months or a year. There are loans that
have interest rate caps of three years. Interest rate caps are
beneficial in rising interest rate markets, but can also keep
your interest rate higher than the fully indexed rate if rates
are falling rapidly. Payment Caps - Some loans have payment caps
instead of interest rate caps. These loans reduce payment shock
in a rising interest rate market, but can also lead to deferred
interest or "negative amortization". These loans generally cap
your annual payment increases to 7.5% of the previous payment.
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Lifetime Caps
- Almost all ARMs have a maximum interest rate or lifetime
interest rate cap. The lifetime cap varies from company to
company and loan to loan. Loans with low lifetime caps usually
have higher margins, and the reverse is also true. Those loans
that carry low margins often have higher lifetime caps.
Standard
ARM Programs
A few options are
available to fit your individual needs and your risk tolerance
with the various market instruments.
ARMs with different
indexes are available for both purchases and refinances. Choosing
an ARM with an index that reacts quickly lets you take full
advantage of falling interest rates. An index that lags behind the
market lets you take advantage of lower rates after market rates
have started to adjust upward.
The interest rate and
monthly payment can change based on adjustments to the index rate.
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6-Month
Certificate of Deposit (CD) ARM Has a maximum interest rate
adjustment of 1% every six months. The 6-month Certificate of
Deposit (CD) index is generally considered to react quickly to
changes in the market.
-
1-Year Treasury
Spot ARM Has a maximum interest rate adjustment of 2% every 12
months. The 1-Year Treasury Spot index generally reacts more
slowly than the CD index, but more quickly than the Treasury
Average index.
-
6-Month Treasury
Average ARM Has a maximum interest rate adjustment of 1% every
six months. The Treasury Average index generally reacts more
slowly in fluctuating markets so adjustments in the ARM interest
rate will lag behind some other market indicators.
-
12-Month Treasury
Average ARM Has a maximum interest rate adjustment of 2% every
12 months. The treasury Average index generally reacts more
slowly in fluctuating markets so adjustments in the ARM interest
rate will lag behind some other market indicators.
Dependable
