Adjustable Rate Mortgage Programs (ARM)

Also known as Variable Rate Mortgages. This is a mortgage where the interest rate may change periodically, usually in relation to an index (such as the Prime Rate, cofi, codi, cmt, libor, or mta) and your payments may rise or fall accordingly. Although payments can change through out the life of the mortgage, there are payment 'caps' and rate 'caps' to protect the borrower by limiting the amount the rate or payment can increase. The 'Fully Indexed Rate' (the interest rate your monthly payments will be based on) is determined by taking the index you have chosen (we'll discuss these later) and adding a 'margin' on top of that indexed rate. The 'margin' is a percentage that the lender adds to cover operating expenses and profit and it remains fixed through out the life of the mortgage. (It should be noted that most Adjustable Rate Mortgages are amortized over a 30 year term.)

People generally choose adjustable rate mortgage programs because the interest rates are always less than those of fixed rate mortgage programs. Additionally, as mortgage rates drop you don't have to refinance in order to take advantage of the decreasing rates.

3 YEAR ADJUSTABLE RATE MORTGAGE This rate is fixed for a period of 3 years and, after that, it goes to the 'Fully Indexed Rate' (which may be higher or lower than the rate at which it had been fixed).

2, 5, 7, and 10 Year Adjustable Rate Mortgage programs are also offered. The more years the rate is fixed for, the higher the interest rate will generally be. So a 3 year ARM will generally have a lower interest rate than a 7 year ARM.

POPULAR MORTGAGE INDEX LIST

Prime Rate - The interest rate banks charge their preferred customers, an average of which is published in the Wall Street Journal.
COFI - Cost of Funds Index is a very stable index based on the average cost of deposits and borrowings for savings institutions in the Federal Home Loan Bank's 11th district (which consists of California, Arizona, and Nevada)
CODI - Similar to COFI but it is based on Certificate of Deposits.
CMT - Constant Maturity Treasury Index is the weekly average yield on the United States Treasury securities adjusted to a constant maturity of 1 year.
MTA - This is based on the same securities as the CMT but it is based on annual yields rather than weekly yields.
LIBOR - London InterBank Offering Rate is the average lending rates from a number of major banks based in London, England. It is commonly used as an international interest rate index. As a side note, the LIBOR should be considered the Index of Choice because it is comparatively low and very stable.

NOTE: MOST OF THESE ADJUSTABLE RATE MORTGAGE PROGRAMS (EXCLUDING PRIME RATE INDEXED ARMS) HAVE SEVERAL PAYMENT OPTIONS INCLUDING

A) INTEREST ONLY OPTION
B)INTEREST AND PRINCIPAL AMORTIZED OVER 30 YEARS
C)INTEREST AND PRINCIPAL AMORTIZED OVER 15 YEARS
D) NEGATIVE AMORTIZATION OPTION.

Ask a loan officer to explain these adjustable rate mortgage options in detail.

NEGATIVE AMORTIZATION (NEG-AM): Negative Amortization loans have a payment option that is allows you to pay less than the fully indexed interest rate. For example, you may have an adjustable rate mortgage based on the Libor with a 'margin' of 2%. Lets say the Libor index was at 2.25%. That means your 'Fully Indexed' rate would be 4.25% (adding the margin to the index gives you the 'Fully Indexed' rate.) A Negative Amortization Mortgage would give you the option to pay, for example, a 1% interest rate rather than the Fully Indexed rate of 4.25% The effect of this is that the interest you are NOT paying is added into your total amount---in other words, your mortgage can actually rise due to accruing unpaid interest. The benefit, ofcourse, is the economic flexibility of being able to 'borrow' against your equity on any given month to lower your payments. While this option provides excellent economic flexiblility it is, however, an option that should be excercised responsibly.

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What choices are there with an adjustable rate mortgage?