Adjustable Rate Mortgage (ARM)

How does an ARM work?

It actually is not as complicated as one would think. It is important that you understand every Adjustable Rate Mortgage has three major components. These components are the Margin, Index and Caps. These three words may not mean a whole lot to you, so let's define them individually so you can have a better understanding as to what they mean. 

Margin =
 Fixed or Constant
Index =
 Variance, ever changing
Caps =
 Liability
Margin + Index =
 Interest rate

ARM Margin

The Margin is the fixed or constant portion of your ARM, this part of your Adjustable Rate Mortgage does not change. It is fixed for the duration of the loan when you take out an Adjustable. You will always have a Margin and it remains the same.

ARM Index

The Index is the ever-changing variance to your Adjustable Rate Mortgage. A few of the typical types of indices are the 11th District Cost of Funds (COFI), the Monthly Treasury Average, the One Year Treasury Bill and the Libor index. The Index is a very important component to your Adjustable because these indices can move very volatility or very conservatively. By adding your Margin (the fixed, constant portion) and your Index (the varying portion) together, you get your interest rate.

So, to recap, Margin + Index = Interest Rate.

ARM Caps

Beyond that, we have what are called Caps. These Caps are what we like to refer to as your liability. Let's give you a specific example of how one particular Adjustable Rate Mortgage works, and it will allow for all three components we just defined to become a part of this process.

Let's say that presently you can get an Adjustable Rate Mortgage at an interest rate of 5%. Your fixed margin is at 2.75% and your adjustable index is tied to the One Year Treasury Bill, which presently has a value of 2.50%.

We just determined that Margin + Index (2.75 + 2.50) = Interest Rate (5.25%). However, your starting interest rate is at 5% on this loan, which is called your introductory teaser rate. So for the first 12 months your interest rate will be at 5%. Since this Adjustable Rate Mortgage has an annual adjustment, at the end of the 12-month cycle, the Lender will add your fixed Margin to the varying Index to get your interest rate for the next 12 months.

So what if your Margin is 2.75% and the Index increases to 7.5% next year?

Margin + Index = 2.75% + 7.5% = 10.25%

Will my rate go that high?" The answer to that question is no, because that is where the Caps (the liability) kick in.

Caps protect you from having uncontrolled increases in your Adjustable.
Let's say this particular Adjustable has what is called a 2% annual and 6% life Cap. What that simply means is, the rate could never go up more than 2% in any annual adjustment period, nor could it ever go up more than 6% for the life of the loan. So, referring to the same example, if you are starting out at 5%, the worst this rate could ever be is 11%. Regardless of what margin and index add up to, with your 2% annual Cap the worst it could be next year is 7%.

So even if next year your Margin + Index = 10.25%, your rate would only go up to 7% because the Cap would kick in and protect you. If Margin + Index is a factor that is less then 7%, the your interest rate would adjust to whatever the Margin + Index equals for that adjustment period.

 

 

    Fannie Mae
    Freddie Mac
   
Ginnie Mae
   
VA
   
FTC
   
FDIC
   
FRB
   
HUD
   
Complaints

 

 Discussion Forum

Recent Posts -

Ads


5/6 ARMs

Homeowners - get fast, easy & free online mortgage answers.
www.jc-capital.net


Adjustable Loans
Search MortgageSector for Low Rate Loans! Get Info & Apply online here.

www.mortgagesector.com

 

 

 

 


By visiting Allie Mae you have taken your first step toward becoming an educated borrower. Allie Mae is an objective, independent source of information for the mortgage consumer. Whether you are buying a home, refinancing, taking a home equity loan, building a home or in need of a mortgage for any purpose, Allie Mae is here to help. Allie Mae has helped thousands of people with their mortgage needs. We have a complete selection of articles, charts, calculators, and checklists designed to help you through the mortgage and home buying process.

© 2004 Copyright AllieMae. All Rights Reserved.
Privacy Policy   Legal  Terms & Conditions   Webmaster   Site Map    Application
About   Contact Us   Forum   Dictionary   Calculators   Articles   Free Content