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Adjustable Rate Loan

Adjustable rate loan products can be useful tools when fixed rates begin to rise. In recent years, many lenders have introduced creative programs which can give you an opportunity to manage your loan payments. Adjustable rate loans have a rate that is fixed for a specific period of time and then begin to adjust periodically. When evaluating any adjustable rate loan there are several things in addition the rate that you will need to evaluate.

1) Fixed Period    An adjustable rate loan will always have a period where the rate is fixed. These fixed periods can range from 1 month to 10 years. There are several measures you should consider when looking at the fixed period such as the length of time you plan to remain in the home and your tolerance for potential changes in rate in the future. One good way to think about this is to consider who is assuming the risk of rates rising. In a 30 year fixed loan, the lender has assumed all of the risk, and you have none so that loan will have the highest rate. At the other end of the scale is the 1 month adjustable rate loan where you have assumed most of the risk and the lender prices the product accordingly.

2) Index                The index the loan is written against is one of the most important factors to consider and I am amazed when I talk with a potential client that another lender simply gave them an interest rate without discussing which index the loan is tied to because the index will have a huge impact on your payment after the fixed period. In years past, an adjustable rate loan was usually tied to the 1 year constant maturity treasury index. Today, loans are available which are tied to many other indexes such as:
        12 MTA- A variant of the 1 year treasury is an average of the most recent 12 months. Very stable
        10 year Treasury Index Stable but not too popular with lenders.
        LIBOR-London Interbank Offering Rate. A 1 month and 6 month index are available. Extremely stable
        COFI-Cost of Funds Index for the 11th Federal District. Stable
        COSI-Cost of Savings Index. Unacceptable stability.
        CODI-Cost of Deposits Index. Unacceptable stability
        Bank Prime Rate. Very unstable, used primarily for home equity lines of credit

Here is a 10 year comparison between a 30 year fixed and fully indexed LIBOR, MTA, COFI, and the 1 year Treasury Index in adjustable rate loan chart form.

3) Margin            The Margin is the number added to the index to determine your interest rate after the initial fixed period. The margin can vary widely from index to index and from lender to lender. Consider this, if the rate is the same on 2 five year adjustable rate loan products but one is indexed against the 10 year treasury which at the time of this writing is at 4.40 and carries a 2.5 margin and the other is indexed against the 1 month LIBOR which is at 1.8 and carries a margin of 2.6, which is the better loan? Clearly it is the LIBOR based product.

4) Caps            All adjustables carry rate change caps, frequently described as 2/6. This would restrict the rate change (up or down) to 2% at any rate change point and no more than 6% over the life of the loan. For example, if you had a start rate of 4.5%, in the worst case, your rate at the change could not be more than 6.5% and the loan could never go above 10.5% at any time. Caps vary from lender to lender and index to index.

I have included a section on the new Cash Flow Adjustable rate loan. A LIBOR or MTA based product which gives you complete flexibility in managing your mortgage.

Read more about Adjustable Rate Loan Closing Costs

Here is a useful Adjustable Rate Loan payment calculator

As a Certified Mortgage Planning Specialist, I offer an analysis of your situation today can make suggestions on how small changes in how your consumer and mortgage debt is structured today can have a life changing effect in the years to come.  Read more about this free, no obligation service.

    Adjustable Rate LoanPrequalify for your Adjustable Rate Loan.

 

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