Standard ARMS and the Differences
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
seven 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.
Introductory Rate
ARM's
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.
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.
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.
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.
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.
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