Adjustable Rate Mortgages (ARMS) are one of the two basic major types of mortgages, the other being a more traditional fixed rate mortgage.
The rate of interest charged for Adjustable Rate Mortgages periodically changes based on some interest related major recognized financial index standard.
The index used varies by lender but generally it’s the London Inter Bank Rate with is the rate available for banks on US Dollar denominate deposits in London (LIBOR), the Prime Rate, the Constant Maturity Treasuries (CMT) which are adjusted daily interest rates for a fixed maturity , One Year Treasury Bill Rate or the Cost Of Funds Index (COFI) which is a composite rate of savings, and other accounts at the Federal Home Loan Bank (FHLB). Lenders can and do use other indexes.
The rate of interest charged for Adjustable Rate Mortgages can increase and decrease during the term of the loan.
The rate of interest charged for Adjustable Rate Mortgages sometimes is capped at a certain maximum level which assures borrowers that the rate charged cannot be exceeded during the term of the loan. Additionally, other features can be included in Adjustable Rate Mortgages, including: monthly payment caps for a specific term, assumability of loan for a new purchaser and a future convertibility option for giving the borrow the ability to convert from an Adjustable Rate Mortgage to one that is fixed.
The terms of the adjustment to the rate charged for the mortgage can vary from as little as monthly to sometimes as long as five years.
Generally, most relatively small borrowers historically have not used Adjustable Rates Mortgages for their financing needs; however, recently more than half of larger mortgage borrowers have been using Adjustable Rate Mortgages.
The major reason for selecting an Adjustable Rate Mortgage versus a Fixed Mortgage is that the monthly payments at least initially are normally lower given typically lower short-term interest rates when compared to long term interest rates. This ”spread” in interest rates in some cases can be several percentage points and can make a very substantial difference in the amount of the monthly payment due during the initial term of the mortgage.
As with a fixed mortgage, repayment of the mortgage is both interest and principal.
The rate charged on Adjustable Rate Mortgages is typically based on current short-term interest rates coupled with a lender’s determination of the loan repayment capabilities of the borrower. Generally, this repayment capability is based on the borrower’s LIFO score (375 to 900), an evaluation of the borrower’s credit history and a grading of the loan from A to D. The higher the score the less the perceived repayment risk and consequently a lower interest rate is made available to the borrower.
Consequently, the cost of borrowing for similar loans with similar loan terms can vary substantially between individual borrowers.
Adjustable Rate Mortgages are offered through mortgage brokers and from direct lenders.
In addition to the rates listed above based on some index, the mortgage brokers and direct lenders can add some sort of margin, fees or additional costs to the interest rate index, this can take the form of “points” other fees, or a “spread”.
Potential users of this type of real estate financing product should: ask questions, check with several offering companies, take your time and compare product offering, and understand the product. Generally speaking Adjustable Rates Mortgages are very complex sophisticated financial instruments and users of these type financial instruments should be conversant with and understand the terms, conditions, tax consequences and other implications of using these products for their real estate mortgage needs.
