Learn The Truth About ARMs
As if there were not enough decisions to make when you are purchasing a house and getting a mortgage, lenders now have such a wide rang of ARMs (adjustable rate mortgages) and the borrower even has to choose the index upon which the ARM will be based!
When we speak of the “index”, we are speaking of the base financial instrument that the changing rates will be based on. Today, banks use various indices, such as the rate on government bonds, or the Fed Fund rate or the London Interbank Offer Rate(LIBOR).
The basic concept of an ARM is that the interest on the loan is adjusted up or down, on a periodic basis, based on a chosen signal interest rate that is indicative of interest rates in general. If your ARM is tied to the CD rate, and the bank’s CD rate goes up, your interest rate will likewise go up. Adjustable rate mortgages have adjustment caps, which says 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. But be aw are, however, that if you just readjusted at an increased rate, and your index rate falls, you are stuck with the increased rate until the next adjustment period.
There are a large number of ARM indices, and they include the CDs, LIBOR and government bonds mentioned. Another index that is frequently used is the Federal Funds Rate. Many of the international banks will employ the LIBOR as the index rate for loans.
How you decide upon the correct index is dependent upon your particular circumstances and how you believe interest rates will change. CD ARMs change every six months, for example, and therefore react more readily to interest rate changes. On the other hand, if your ARM is based on T Bills, it will react more slowly. One of the fastest indices to change is the LIBOR, so if you want your interest rate to move often, because you think rates are going to decrease, this is a good choice.
As we said, new products are introduced each day, and one of the newest it the option ARM, which allows the borrower to pick how much he wants to pay on his mortgage each month. The mechanism behind these loans is that they are interest interest only loans, so you have to pay that minimum, and then you have the choice to pay more. One of the big issues with an option mortgage is that you can end up with an increasing instead of decreasing mortgage; this is also known as negative amortization.
This is a lot of information for the home buyer to digest, and the best solution is to talk to a professional mortgage broker who can explain it all and recommend the best course for you.
