Adjustable Rate Mortgages (ARMs)
Adjustable Rate Mortgages (ARMs) have a distinct advantage of beginning with a lower interest rate than that of a fixed rate mortgage, typically, 1-2 percent below a comparable fixed rate mortgage. While this could be allow a potential homeowner to buy a more expensive home because of a reduced payment, after a varied period of time (typically, 3, 5, 7 or 10 years) the interest rate changes and rates (along with the payments) inevitable go up as interest rates change. There are several characteristics to ARM loans. They include the Index, the Margin, Change Caps, Payment Caps, and lifetime Caps. We’ll do our best to summarize but it’s strongly suggested that you contact an Efinity Home Loans Licensed Financial Professional for a further explanation to these products.
The index of an ARM is the financial instrument that the loan is “tied” to, or adjusted to. The most common indices are the 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI). Each of these indices move up or down based on conditions of the financial markets.
The margin is one of the most important aspects of ARMs because it is added to the index to determine the interest rate that you pay. The margin added to the index is known as the fully indexed rate. As an example if the current index value is 5.50% and your loan has a margin of 2.5%, your fully indexed rate is 8.00%. Margins on loans range from 1.75% to 3.5% depending on the index and the amount financed in relation to the property value.
All adjustable rate loans carry interim caps. Many ARMs have interest rate caps of six months or a year. There are loans that have interest rate caps of three years. Interest rate caps are beneficial in rising interest rate markets, but can also keep your interest rate higher than the fully indexed rate if rates are falling rapidly.
Some loans have payment caps instead of interest rate caps. These loans reduce payment shock in a rising interest rate market, but can also lead to deferred interest or “negative amortization.” These loans generally cap your annual payment increases to 7.5% of the previous payment.
Almost all ARMs have a maximum interest rate or lifetime interest rate cap. The lifetime cap varies from company to company and loan to loan. Loans with low lifetime caps usually have higher margins, and the reverse is also true. Those loans that carry low margins often have higher lifetime caps.
Contact us for more information on Adjustable Rate Mortgages (ARMs).