Introductory
Rate ARM's
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.