Title:
Adjustable Rate
Mortgages – Determining Rates
Word Count:
539
Summary:
Adjustable rate
mortgages are to home buyers as carrots are to bunnies – very tempting. The
secret to figuring out if an adjustable rate mortgage is a good deal is the rate
index used.
Keywords:
adjustable rate
mortgages, t-bills, treasure bills, interest rates, libor, cost of funds index,
cofi
Article Body:
Adjustable rate
mortgages are to home buyers as carrots are to bunnies – very tempting. The
secret to figuring out if an adjustable rate mortgage is a good deal is the
rate index used.
Indexes – Setting Rates
Lenders really want your business and are willing to create enticing loan
products to get it. Occasionally, lenders will offer adjustable rate mortgages
that offer a lot of carrot on the front end, but none on the back end. These
loans are typically offered to you with an insanely low initial interest rate,
which has you looking at mansions and other structures completely out of your
realistic price range. The problem with these loans is the rate rises
dramatically after six months or a year when the rate becomes pegged to an
index.
Indexes are a unique animal when it comes to the mortgage industry. An index is
a calculation of general interest rates charged across a number of financial
markets that a bank uses to set a real interest rate on your loan. Common
financial markets or products considered in this index include six month
certificate deposit rates at local banks, LIBOR, T-Bills and so on. Let’s take
a closer look.
1. Certificate Deposits – Better known as “CDs”, these are the fixed time
period investing vehicles you can get at your local bank. You agree to deposit
a certain amount for six months and the bank gives you a guaranteed interest
rate of return such as three percent.
2. T-Bills – Officially known as Treasury Bills, T-Bills are the credit cards
for the federal government. Currently, Uncle Sam owes trillions of dollars on
his and pays a certain interest rate on the debit. The interest rate is used by
lenders in calculating your ARM rates.
3. Cost of Funds Index – It gets a bit technical, but this index represents the
rates being used by banks in Nevada, Arizona and California as an
average.
4. LIBOR – Officially known as the London Interbank Offered Rate Index, LIBOR
is a popular index upon which to base ARM rates. Now, you are probably
wondering what London has to do with the United States real estate market.
LIBOR represents the interest rate international banks charge to borrow U.S.
dollars on the London currency markets. LIBOR rates move quickly and can result
in unstable interest rate moves for your adjustable mortgage.
Why Indexes Matter
Indexes matter because they set the base of the interest rates charged on your
loan. Assume you apply for an adjustable rate mortgage based on a LIBOR index.
Assume the LIBOR rate is 2.2 percent when you apply. The 2.2 percent is your
starting interest rate. If the LIBOR shoots up one percent in eight months,
your loan will do the same.
Importantly, the index rate used for your loan is not the interest rate you
will pay. Instead, you have to add the banks margin on top of the index rate.
Most banks will charge two to three percent on top of the index rate. Using our
LIBOR example, the initial interest rate of your loan would be 2.2 percent plus
whatever the bank is using as a spread. Obviously, this means you need to
closely read the loan documents to figure out how the game is being played!