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Adjustable Rate Mortgages
Understanding Your ARM Loan
In 2005 and 2006 approximately 60% of California home purchases were financed through the utilization of Adjustable Rate Mortgages – ARM’s or “Toxic Mortgages” as they are known by the popular media. Re-financings utilizing ARM’s accounted for approximately 30% of all real estate transactions. Industry analysts estimate $2 trillion of ARM’s will re-set in 2009, 2010, and 2011 resulting in significantly higher payments for borrowers and ultimately dramatically higher loan default rates.
Current mortgage default rates in California are at historical highs and rapidly accelerating. If you are having difficulties making payments on your ARM, having a clear understanding of the basic terms of your ARM is absolutely necessary. The following provides basic information:
What is an ARM Loan?
An ARM loan (Adjustable Rate Mortgage) is a mortgage where the interest rate is not fixed, but changes during the life of the loan in line with movements in an index rate.
What is a Margin?
The margin is the number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment.
What is an Index?
An Index is economic indicator that lenders use to set an adjustable rate mortgage’s interest rate. Each ARM is tied to a specific index. Since some indices move up and down faster than others, it’s a good idea to know which index is connected to your ARM. Some common indexes are:
- Constant Maturity Treasury (CMT or TCM)
- Treasury Bill (T-Bill)
- 12-Month Treasury Average (MTA or MAT)
- Certificate of Deposit Index (CODI)
- 11th District Cost of Funds Index (COFI)
- Cost of Savings Index (COSI)
- London Inter Bank Offering Rates (LIBOR)
- Certificates of Deposit (CD) Indexes
- Bank Prime Loan (Prime Rate)
CMT, COFI, and LIBOR indexes are the most frequently used. Approximately 80% of all the ARMs today are based on one of these indexes.
Will I know in advance how much my payment may go up?
With an adjustable rate mortgage, the exact amount of future monthly payments may be uncertain. Some types of ARM loans have a ceiling on your payment increase or interest-rate increase from one period to the next.
How is the interest rate calculated on an ARM loan?
Most ARM loans calculate the interest rate by adding a margin to the index.
What is the ARM adjustment period?
The frequency with which your interest rate may change is called the ARM adjustment period. The most common ARM adjustment periods are every 6 months or 12 months. The frequency of ARM adjustments will be outlined in our ARM Note.
What is Adjustment Date?
The Adjustment Date is the day when the interest rate changes on an adjustable rate mortgage (ARM). After an initial period where an ARM loan interest rate remains the same, the rate changes on the adjustment date to reflect the new ARM loan rate. The ARM loan rate will then continue to adjust over the life of the loan.
What is Interest Rate Cap?
The limit on how much the interest rate on an adjustable rate mortgage (ARM) can go up. Most ARM loans have two types of interest rate caps:
- Lifetime caps, which are required by law, limit the increase of a rate over the full course of a loan. A 6% lifetime cap, for example, means the rate cannot go beyond 6% points over the initial rate. A lifetime cap is also referred to as a ceiling. Some loans also have a floor which limits the decrease of a rate over the full course of a loan.
- Periodic caps, which limit the rate change from one adjustment period to the next, even if the market interest rates significantly rise or fall during this time.
What is Initial Interest Rate?
The starting interest rate of an adjustable rate mortgage (ARM). The initial interest rate on an ARM loan is fixed for a certain period then adjusts to reflect overall market rates. Fixed rate loans, on the other hand always have the same interest rate for the life (i.e. the full term) of the loan.
