Learn The Truth About ARMs
Worrying about what kind of mortgage you want to take is difficult enough, without having to decide on which interest rate index is going to be the deciding factor on what your interest rates on your Adjustable Rate home loan will be!
The index of an ARM (Adjustable Rate Mortgage) is the financial standard upon which the rate changes will be made. Today, banks use different indices, such as the rate on government debt, or the Fed Fund interest or the London Interbank Offer Rate(LIBOR).
Interest rates on ARMS change, upwards or downwards, based on how overall rates are moving, which is reflected in the movement of the underlying index rate. For example, if you pick the CD rate as your index, when CD rates go up, your home loan rate will increase. ARMS also have adjustment caps, so that you can limit your exposure as to how high your loan rate can go, even if your index rate continues to go up, which is good if you just had a change, and the rates go up again. Of course, the opposite can happen, and if your rate has recently been readjusted at a high rate, and then the index moves down, you cannot take advantage of that until your next readjustment period.
The list of instruments that ARMs can be tied to reads like alphabet soup nowadays, from CDs to LIBOR. The Fed Funds rate is one of the most popular basis for ARMs. Many of the international banks will employ the LIBOR as the index rate for mortgages.
The index is a personal choice, based on the individual mortgage, and how the borrower feels interest rates will behave. If you would like a rate that is responsive to the interest rate market, you would choose the CD rate as your benchmark. Adjustable rate mortgages that use T Bills will adjust more slowly. Quickest 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 choices is the option ARM, which permits the borrower to decide the “option” of choosing his mortgage payment each month. Of course, there is a minimum, usually the amount of interest, so the bank can guarantee its return, and then the balance goes toward the mortgage principle. There is a real danger in option mortgages that the loan will end up with negative amortization, which means the mortgage balance increases instead of decreasing as it usually would.
This is a lot of information for the borrower to digest, and the best solution is to consult with a professional mortgage broker who can explain it all and recommend the best solution for you.
