Introductory Rate ARM's
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.
- 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.
- 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.
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.
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.
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.
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