Northlawn Financial, Inc.

 

An Adjustable Rate Mortgage (ARM) has an interest rate that changes periodically usually in relation to an index and the monthly payments may go up or down accordingly. The index for your particular loan is established at the time of application.
The new Interest Rate will be determined by the current Index, plus the Margin.

Well Known Indexes include:
Constant Maturity Treasury (CMT)
Treasury Bill (T-Bill)
12-Month Treasury Average (MTA)
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
Prime Rate

The margin is fixed percentage points added to the index to compute the interest rate. The result will then be rounded to the nearest one-eighth of a percent. The margins remain fixed for the term of the loan and are not impacted by the financial markets and movement of interest rates. Lenders use a variety of margins depending upon the loan program and adjustment periods. Most ARMs have an interest rate caps to protect you from enormous increases in monthly payments. A lifetime cap limits the interest rate increase over the life of the loan. A periodic or adjustment cap limits how much your interest rate can rise at one time. With most ARMs, the interest rate can adjust every six months, once a year, every three years, or every five years.

Fixed-period ARM's

With fixed-period ARM's, homeowners can enjoy from three to ten years of fixed payments before the initial interest rate changes. At the end of the fixed period, the interest rate will adjust annually. Fixed-period ARM's -- 3/1, 5/1, 7/1 and 10/1 -- are generally tied to the one-year Treasury securities index. Fixed period ARM's, in addition to lifetime and yearly adjustment caps, have an initial adjustment cap. It limits the interest rate you will pay the first time your rate is adjusted. All adjustment caps vary with the type of loan program.

The advantage of these loans is that the interest rate is lower than for a 30-year fixed (the lender is not locked in for as long so their risk is lower and they can charge less) but you still get the advantage of a fixed rate for a period of time.

Convertible ARM's

Some ARM's come with option to convert them to a fixed-rate mortgage at designated times (usually during the first five years on the adjustment date), if you see interest rates starting to rise. The new rate is established at the current market rate for fixed-rate mortgages.
The conversion is typically done for a nominal up-front fee and requires almost no paperwork. The disadvantage is that the conversion interest rate is typically a little higher than the market rate at that time.

Negatively amortizing ARM's

Some types of ARM's offer payment caps rather than interst rate caps, which limit the amount the monthly payment can increase. If a loan has payment cap but has no periodic interest rate cap, then the loan may become negatively amortized: if the interest rates rise to the point that the monthly mortgage payment does not cover the interest due, any unpaid interest will get added to the loan balance, so the loan balance increases. However, you always have the option to pay the minimum monthly payment, or the fully amortized amount due. The interest rate on negatively amortized loans can adjust monthly.