 Jessica
Community Mentor
Joined: 08 Jun 2004
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Location: OHIO
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 Posted: Sat Nov 11, 2006 2:52 am Post subject: What are the basic features of ARMs? |
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The ARMs or adjustable rate mortgages have three features - the fully indexed rate, the index and the margin. The fully indexed rate/standard rate on an ARM is determined by the sum of the financial index and the margin. Some of the common indexes widely used are the Prime Rate usually charged by banks, 1 year Treasury Bill, the 6-month LIBOR (London Interbank Offered Rate), COSI, COFI and others.
Usually lenders offer an initial interest rate that is lower than the standard ARM rate (that is, lower than the sum of the index and the margin). Such a rate is known as Discounted Rate or the Teaser Rate. For example, if the standard rate is 9.55%, then the initial rate may be far below, say around 6.15%. The teaser rates are combined with large initial fees or points and much higher rates that are applied after the discount period expires.
Let's take an example on how you can benefit from a discounted rate.
Let us consider that the standard ARM rate (index plus margin) is currently 10%. But the lender offers a discounted rate of 8% for the first year. On a loan amount of $50,000 at interest rate of 8%, the monthly payments for the first year will be $ 366.88 instead of $438.79 at a rate of 10%. Thus, you can save $71.91 per month and $862.92 by the end of first year. As soon as the discount period is over, your monthly payments will be calculated on the basis of the standard rate (prevailing index plus margin).
How the fully indexed rate fluctuates
The fully indexed rate fluctuates with a variation in the index thereby changing the monthly payments at an interval of a certain time period known as the adjustment period. Usually the rates change annually but it may vary semi-annually depending upon how often the index changes. At the time of each rate adjustment, the new value of the index is added to the margin which remains unchanged and the new standard rate is thus obtained. However, the interest rate on an adjustable rate mortgage cannot go up beyond a certain limit for an adjustment period or for the life of the loan. This is due to the presence of periodic and lifetime interest rate caps.
The adjustable rate mortgages are suitable for borrowers who wish to extend their buying power and wish to save money for the initial years of the loan. The best way to determine whether an adjustable rate loan is right for you is to analyze your financial situation and your short term and long term financial goals.
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