ARMs Are Not That Difficult to Understand
In addition to all of the other decisions you have to make when you are choosing a home loan, such as whether to go fixed or floating rate, how much down payment to make and how many points to pay, lenders have further complicated everything by offering a wide range of choice of indexes for ARMs (adjustable rate mortgages).
When we speak about the index for the ARM, we are speaking about the standard that the adjustments to the mortgage rate will be tied to. Today, banks use different indices, such as the rate on government debt, or the Fed Fund rate or the London Interbank Offer Rate(LIBOR).
You must initially understand that an ARM is a loan with an interest rate that moves up or down within a certain set period, and the movements are predicated upon the movements of the underlying index. One such instrument would be Certificates of Deposit-your mortgage rate would fluctuate up and down with the CD rate. An additional feature of an ARM is that there is an adjustment cap, which prevents the interest from moving up or down too often, even if the index does; sometimes this can be an advantage if you just adjusted and then rates move upwards. But be aw are, however, that if you just readjusted at a higher rate, and your index rate goes down, you are stuck with the higher rate until the next adjustment period.
ARMs can be tied to any number underlying instruments, for example the 90 day U.S. Treasury Bill. The Fed Fund rate is what banks pay to the Federal Reserve Bank for funds. LIBOR is the London Interbank Offered rate, which is the rate that commercial borrowers pay each other for the use of funds.
Deciding upon which index is the one for you will depend on your own circumstances as well as your view of interest rate movements. If you prefer a rate that is responsive to the interest rate market, you would choose the CD rate as your index. On the other hand, if your ARM is based on T Bills, it will move more slowly. One of the fastest indices to change is the LIBOR, so if you want your interest rate to move frequently, because you think rates are going to decrease, this is a good choice.
An option ARM is one where the interest rate adjusts monthly and the payment adjusts every year, and the borrower is offered an "option" on how large a payment he would like to make. Of course, there is a minimum, usually the amount of interest, so the lender can guarantee its return, and then the balance goes toward the mortgage principle. One of the big issues with an option mortgage is that you can end up with an increasing instead of decreasing mortgage; this is also called as negative amortization.
With this dizzying choice in interest rate options for your mortgage, the best idea is to meet with a mortgage expert who can explain all of them to you and advise you best on your needs.
When we speak about the index for the ARM, we are speaking about the standard that the adjustments to the mortgage rate will be tied to. Today, banks use different indices, such as the rate on government debt, or the Fed Fund rate or the London Interbank Offer Rate(LIBOR).
You must initially understand that an ARM is a loan with an interest rate that moves up or down within a certain set period, and the movements are predicated upon the movements of the underlying index. One such instrument would be Certificates of Deposit-your mortgage rate would fluctuate up and down with the CD rate. An additional feature of an ARM is that there is an adjustment cap, which prevents the interest from moving up or down too often, even if the index does; sometimes this can be an advantage if you just adjusted and then rates move upwards. But be aw are, however, that if you just readjusted at a higher rate, and your index rate goes down, you are stuck with the higher rate until the next adjustment period.
ARMs can be tied to any number underlying instruments, for example the 90 day U.S. Treasury Bill. The Fed Fund rate is what banks pay to the Federal Reserve Bank for funds. LIBOR is the London Interbank Offered rate, which is the rate that commercial borrowers pay each other for the use of funds.
Deciding upon which index is the one for you will depend on your own circumstances as well as your view of interest rate movements. If you prefer a rate that is responsive to the interest rate market, you would choose the CD rate as your index. On the other hand, if your ARM is based on T Bills, it will move more slowly. One of the fastest indices to change is the LIBOR, so if you want your interest rate to move frequently, because you think rates are going to decrease, this is a good choice.
An option ARM is one where the interest rate adjusts monthly and the payment adjusts every year, and the borrower is offered an "option" on how large a payment he would like to make. Of course, there is a minimum, usually the amount of interest, so the lender can guarantee its return, and then the balance goes toward the mortgage principle. One of the big issues with an option mortgage is that you can end up with an increasing instead of decreasing mortgage; this is also called as negative amortization.
With this dizzying choice in interest rate options for your mortgage, the best idea is to meet with a mortgage expert who can explain all of them to you and advise you best on your needs.
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