The Secret to Understanding ARMs
Worrying about what kind of mortgage you want to take is hard enough, without also deciding on which interest rate index is going to be the deciding factor on what your interest rates on your Adjustable Rate mortgage will be!
When we speak of the "index", we are talking about of the base financial instrument that the changing rates will be based on. These indices may be such instruments as the T-Bill rate, the rate of Federal Funds, or rates based on LIBOR.
The rate on an ARM is adjusted periodically upwards, or downwards, based upon the movement in the general interest rate environment, but tied to a specific instrument. If your ARM is tied to the CD rate, and the bank's CD rate goes up, your interest rate will likewise go up. Adjustable rate mortgages have adjustment caps, which means that the interest rate can only be adjusted at certain periods, even if the underlying interest rate goes up more often; this can be an advantage if you just readjusted and then rates move up. Of course, the opposite can happen, and if your rate has recently been readjusted at a high rate, and then the index moves down, you will not be able to take advantage of that until your next readjustment period.
The list of instruments that ARMs can be linked with reads like alphabet soup today, from CDs to LIBOR. The Fed Funds rate is one of the most popular basis for ARMs. Another popular index used by a lot of lenders is the LIBOR, or the London Interbank Offered Rate, which highly rated international companies pay to borrow.
Which is the right choice depends on your situation circumstances and your view of where interest rates are heading. If you would like a rate that is responsive to the interest rate market, you should choose the CD rate as your index. Rates on Treasury instruments such as the Treasury Bill change more slowly than CDs, and so will react more slowly to interest rate changes. LIBOR is one of the quickest moving indices, so if you want to take advantage of rapidly falling interest rates, this is the one to use.
An option ARM is one in which the interest rate adjusts monthly and the payment adjusts every year, and the borrower is offered an "option" on how large a payment he would like to make. There is a minimum payment that covers the interest (so the bank gets its money) and then the other options will pay off some portion of equity. Be warned that minimum payment option can result in an increasing, rather than decreasing mortgage, a phenomenon known as negative amortization.
This is a lot of information for the borrower to digest, and the best solution is to consult with a professional mortgage broker who can explain it all and recommend the best solution for you. - 23211
When we speak of the "index", we are talking about of the base financial instrument that the changing rates will be based on. These indices may be such instruments as the T-Bill rate, the rate of Federal Funds, or rates based on LIBOR.
The rate on an ARM is adjusted periodically upwards, or downwards, based upon the movement in the general interest rate environment, but tied to a specific instrument. If your ARM is tied to the CD rate, and the bank's CD rate goes up, your interest rate will likewise go up. Adjustable rate mortgages have adjustment caps, which means that the interest rate can only be adjusted at certain periods, even if the underlying interest rate goes up more often; this can be an advantage if you just readjusted and then rates move up. Of course, the opposite can happen, and if your rate has recently been readjusted at a high rate, and then the index moves down, you will not be able to take advantage of that until your next readjustment period.
The list of instruments that ARMs can be linked with reads like alphabet soup today, from CDs to LIBOR. The Fed Funds rate is one of the most popular basis for ARMs. Another popular index used by a lot of lenders is the LIBOR, or the London Interbank Offered Rate, which highly rated international companies pay to borrow.
Which is the right choice depends on your situation circumstances and your view of where interest rates are heading. If you would like a rate that is responsive to the interest rate market, you should choose the CD rate as your index. Rates on Treasury instruments such as the Treasury Bill change more slowly than CDs, and so will react more slowly to interest rate changes. LIBOR is one of the quickest moving indices, so if you want to take advantage of rapidly falling interest rates, this is the one to use.
An option ARM is one in which the interest rate adjusts monthly and the payment adjusts every year, and the borrower is offered an "option" on how large a payment he would like to make. There is a minimum payment that covers the interest (so the bank gets its money) and then the other options will pay off some portion of equity. Be warned that minimum payment option can result in an increasing, rather than decreasing mortgage, a phenomenon known as negative amortization.
This is a lot of information for the borrower to digest, and the best solution is to consult with a professional mortgage broker who can explain it all and recommend the best solution for you. - 23211
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