Today we learn about the ARM, or Adjustable Rate Mortgage
PARTS OF THE ARM
Rate: determined by an index plus a margin
Index: set by a neutral third party (lender or borrower doesn’t control it). Third Parties who determine indexes include:
- COFI:11th district cost of funds
- LIBOR: London Interbank Offered Rate (monthly)
- CMT: Constant Maturity Treasuries
- MAT: Monthly Average Treasuries (12 month period)
- Prime
Margin: An agreed upon spread….often 2-3% or more. It is the lenders “mark-up” or cost of doing business. It can vary by risk, down payment or other factors.
Index + Margin = Interest rate
Example: If the 11th District Cost of Funds available in December was 4.662, then a loan with a margin of 2.4 would have and interest rate of 7.062 percent for January (the index through January has dropped to 4.172 so it will probably affect March payments. There’s a slight lag).
Payment: The payment may or may not cover all of the interest. Minimum payment will be determined by the terms in the promissory note.
Negative Amortization: If the payment agreed does not cover the interest, there will be negative amortization - the loan will get larger and interest will accrue on the larger balance.
Interest Rate Cap: Predetermined limits on the maximum and minimum rates that can be charged on the loan.
Payment Cap: If the interest rate jumped quickly, the payment would still stay stable for the agreed period, often six or 12 months.
Hybrid ARM: A combination of fixed and adjustable. Most common types are fixed for one, three, five, seven or 10 years before they start adjusting. Fixed start rate is lower for shorter time periods. Longer time periods (like the 10 or 30 year) are higher rates since lender will build in predicted risk. However, buyer has security of predicted interest and payments.
Teaser Rate: Short term rate of perhaps one to six months before rate and/or payment changes. Some of the teaser rates have been as low as 1 to 4 percent and lenders have allowed buyers To qualify with these low rates.
Use of teaser rates has been a source of the problems with foreclosures:
Example: $250,000 loan
1.000% $208/mo.
4.000% $833/mo.
7.062% $1,471/mo.
Some of the rates should be eased in the next few months if the indexes start to reflect the lowered short term rates.
Maxine breaks down the Adjustable Rate Mortgage and tells why you should shop your margin as well as your interest rates.
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