The Key to Understanding ARMs
In addition to all of the other decisions you have to make when you are choosing a mortgage, 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 matters by offering a wide range of choice of indexes for ARMs (adjustable rate mortgages).
When we speak of the "index", we are speaking of the base financial instrument that the changing rates will be based on. These indices could be such instruments as the T-Bill rate, the rate of Federal Funds, or rates based on LIBOR.
The rate on an ARM is adjusted periodically upwards, or downwards, based upon the movement in the general interest rate environment, but tied to a specific instrument. One such instrument would be Certificates of Deposit-your mortgage rate would fluctuate up and down with the CD rate. Adjustable rate mortgages have adjustment caps, which means that the interest rate can only be adjusted at certain periods, even if the underlying interest rate goes up more often; this can be an advantage if you just readjusted and then rates move up. This can be a disadvantage if you have just readjusted, and then there is a downward movement, however.
There are a large number of ARM indices, and they include the CDs, LIBOR and government bonds mentioned. Another index that is often used is the Federal Funds Rate. LIBOR is the London Interbank Offered rate, which is a 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 situation as well as your view of interest rate movements. If you have an ARM that uses CDs as its index, you can expect it to be very responsive to market moves. On the other hand, if your ARM is based on T Bills, it will move more slowly. Fastest of all in reaction time is the LIBOR, so if you feel that rates are falling and want to take advantage of each downward move, this is the index for you.
An interesting, and possibly dangerous choice in interest rate options is the option ARM, which permits the borrower to decide the "option" of choosing his mortgage payment each month. There is a minimum payment that allows for the interest (so the bank gets its money) and then the other options will pay down some portion of equity. Those using this option should be aware of negative amortization, since they may never repay any of the loan if they always choose the lowest amount.
With this dizzying choice in interest rate scenarios for your mortgage, the best option is to meet with a mortgage expert who can explain all of them to you and advise you best on your needs. - 16931
When we speak of the "index", we are speaking of the base financial instrument that the changing rates will be based on. These indices could be such instruments as the T-Bill rate, the rate of Federal Funds, or rates based on LIBOR.
The rate on an ARM is adjusted periodically upwards, or downwards, based upon the movement in the general interest rate environment, but tied to a specific instrument. One such instrument would be Certificates of Deposit-your mortgage rate would fluctuate up and down with the CD rate. Adjustable rate mortgages have adjustment caps, which means that the interest rate can only be adjusted at certain periods, even if the underlying interest rate goes up more often; this can be an advantage if you just readjusted and then rates move up. This can be a disadvantage if you have just readjusted, and then there is a downward movement, however.
There are a large number of ARM indices, and they include the CDs, LIBOR and government bonds mentioned. Another index that is often used is the Federal Funds Rate. LIBOR is the London Interbank Offered rate, which is a 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 situation as well as your view of interest rate movements. If you have an ARM that uses CDs as its index, you can expect it to be very responsive to market moves. On the other hand, if your ARM is based on T Bills, it will move more slowly. Fastest of all in reaction time is the LIBOR, so if you feel that rates are falling and want to take advantage of each downward move, this is the index for you.
An interesting, and possibly dangerous choice in interest rate options is the option ARM, which permits the borrower to decide the "option" of choosing his mortgage payment each month. There is a minimum payment that allows for the interest (so the bank gets its money) and then the other options will pay down some portion of equity. Those using this option should be aware of negative amortization, since they may never repay any of the loan if they always choose the lowest amount.
With this dizzying choice in interest rate scenarios for your mortgage, the best option is to meet with a mortgage expert who can explain all of them to you and advise you best on your needs. - 16931
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