ARM or Adjustable Rate Mortgage

ARM products can be useful tools when fixed rates begin to rise. In recent years, many lenders have introduced some vary creative ARM programs which can give you an opportunity to actively manage your mortgage payments. When evaluating any ARM, there are several things in addition the ARM rate that you will need to know. Email me with questions about your ARM

1) Fixed Period An ARM will always have a period of time 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 that risk. In a 30 year fixed loan, the lender has assumed all of the interest rate risk, and you have none so that loan will have the highest rate. At the other end of the scale is the 1 year ARM loan where you have assumed most of the risk and the lender prices the product accordingly.

2) Index The index the ARM is written against is one of the most important factors to consider and I am constantly amazed when I talk with a potential client that another lender simply gave them an interest rate without even discussing which index the ARM is tied to because the ARM index will have a huge impact on your rate after the fixed period. In years past, an adjustable rate mortgage was usually tied only to the 1 year constant maturity treasury index (the average cost of short term borrowing by the Federal Government). However, 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 average comparison between a 30 year fixed and fully indexed LIBOR, MTA, COFI, and the 1 year Treasury Index in ARM chart form.

Fixed         7.710%
T Bill          7.708% average of 4.833 with a 2.875% margin
COFI         7.490% average of 4.590 with a 2.9% margin
MTA          7.442% average of 4.942 with a 2.5% margin
LIBOR       7.102% average of 4.852 with a 2.25% margin

3) Margin The ARM Margin is the number which is added to the index to determine your interest rate after the initial fixed period. The ARM 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 mortgages 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 ARMs 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 can vary from lender to lender and index to index.

Many of my clients are converting from fully amortizing payments to an interest only approach with a significantly lower monthly payment. I have some extensive information available.

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