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Adjustable Rate Mortgages These loans generally begin with an
interest rate that is 1-3 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 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. 6-Month Certificate of Deposit (CD) ARM 1-Year Treasury Spot ARM 6-Month Treasury Average ARM 12-Month Treasury Average ARM Introductory
Rate ARM's
Most adjustable rate loans (ARMs) have a
low introductory rate or start rate, some times as much as 4.0-5.0% 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. LIBOR
- London InterBank Offered Rate
LIBOR is the rate on dollar-denominated
deposits, also know as Eurodollars, traded between banks in London. The
index is quoted for one month, three months, six months as well as
one-year periods. LIBOR is the base interest rate paid on
deposits between banks in the Eurodollar market. A Eurodollar is a dollar
deposited in a bank in a country where the currency is not the dollar. The
Eurodollar market has been around for over 40 years and is a major
component of the International financial market. London is the center of
the Euromarket in terms of volume. The LIBOR rate quoted in the Wall Street
Journal is an average of rate quotes from five major banks. Bank of
America, Barclays, Bank of Tokyo, Deutsche Bank and Swiss Bank. The most common quote for mortgages is the
6-month quote. LIBOR's cost of money is a widely monitored international
interest rate indicator. LIBOR is currently being used by both Fannie Mae
and Freddie Mac as an index on the loans they purchase. LIBOR is quoted daily in the Wall Street
Journal's Money Rates and compares most closely to the 1-Year Treasury
Security index. COFI
ARM Cost of Funds Index
The 11th District Cost of Funds is more
prevalent in the West and the 1-Year Treasury Security is more prevalent
in the East. Buyers prefer the slowly moving 11th District Cost of Funds
and investors prefer the 1-Year Treasury Security. The monthly weighted average Eleventh
District has been published by the Federal
Home Loan Bank of San Francisco since August 1981. Currently more than
one half of the savings institutions loans made in California are tied to
the 11th District Cost of Funds (COF) index. The Federal Home Loan Bank's 11th District
is comprised of saving institutions in Arizona, California and Nevada. Few people who use and follow the 11th
District Cost of Funds understand exactly how it is calculated, what it
represents, how it moves and what factors affect it. The predecessor to the 11th District Cost
of Funds index was the District semiannual weighted average cost of funds
published for a six month period ending in June and December. The San
Francisco Bank was the first Federal Home Loan Bank to publish a monthly
cost of funds index. The funds used as a basis for the
calculation of the 11th District Cost of Funds index are the liabilities
at the District savings institutions: money on deposit at the
institutions, money borrowed from a Federal Home Loan Bank (known as
advances) and all other money borrowed. The interest paid on these types
of funds is the cost of these funds. The ratio of the dollar amount paid in
interest during the month to the average dollar amount of the funds for
that month constitutes the weighted average cost of funds ratio for that
month. The average cost of funds is said to be
weighted because the three kinds of funds and their costs are added
together before a ratio is computed rather than calculating averages
individually for the three sources and using a simple average of the three
ratios. This gives the greatest weight to the interest paid on deposits,
and explains the delayed reaction of the index to rising fixed-rate
mortgages. Apply Online
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