Most
adjustable rate loans (ARMs) have a low introductory
rate or start rate, some times as much as 5.0% below
the current market rate of a fixed loan. This start
rate is usually good from 1 month to as long as 10 years.
As a rule the lower the start rate the shorter the time
before the loan makes its first adjustment.
Index
- The index of an ARM is the financial instrument
that the loan is "tied" to, or adjusted to. The most
common indices, or, indexes 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.
Margin
- 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.
Interim
Caps - 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.
Payment
Caps - 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.
Lifetime
Caps - 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.
