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ARM (adjustable rate mortgage)…
An Adjustable Rate Mortgage (ARM) is a mortgage
loan that does not charge a fixed rate of
interest; it is a mortgage with an interest
rate that is linked to an economic index.
The interest rate -- and
your payments -- are periodically adjusted
up or down as the index fluctuates.
The initial interest rate for an ARM is lower
than that of a fixed rate mortgage, where
the interest rate remains the same during
the life of the loan. Even when fixed interest
rates are low, the starting rate on ARM loans
are still lower. Of course, this lower rate
may be only temporary, depending on future
interest rate movements. A lower rate means
lower payments, which might help you qualify
for a larger loan.
Indexes
An index is a guide that lenders use to measure
interest rate changes. Most lenders use the
yield on the one year T-bill as an index,
but there are many others. Each ARM is linked
to a specific index. Well known indexes include:
· Constant Maturity Treasury (CMT)
· Treasury Bill (T-Bill)
· 12-Month Treasury Average (MTA)
· 11th District Cost of Funds Index
(COFI)
· London Inter Bank Offering Rates
(LIBOR)
· Certificates of Deposit (CD) Indexes
· Prime Rate
Margins
The margin is the lender's markup. It is a
defined interest rate that represents their
cost of doing business plus the profit they
will make on the loan. This margin is added
to the index rate to determine your total
interest rate. It usually stays the same during
the life of the loan. The margin can vary
widely from lender to lender
(2 - 3.5%)
Adjustment
Periods
This is the period between potential rate
adjustments, which can be as frequent as a
month or several years. Generally adjustments
are described as 1/1 year or 3/1 year or 5/1
year or 5/5 year, which translates as: the
first number is the amount of years you will
pay the same initial payment, then starting
the next year (or number) your rate (payment)
will be adjusted every year after.
(i.e. 3/1 means you make the same payment
the first 3 years then on the 4th year your
rate (payment) will be adjusted and adjusted
once every year there after.)
Rate Caps /
Payment Caps
Rate caps limit how much interest you can
be charged. Your lender will establish a maximum
amount (cap) that your rate can change each
adjustment period.
Periodic caps -limit the
amount your interest rate can increase from
one adjustment period to the next. Not all
ARMs have periodic rate caps.
Overall caps - limit how
much the interest rate can increase over the
life of the loan. Overall caps have been required
by law since 1987.
Payment Caps - limit how
much your monthly payment can increase at
each adjustment. ARMs with payment caps often
do not have periodic rate caps. |
