Indexes - An index is the published interest rate to which the interest rate on an Adjustable Rate Mortgage (ARM) is tied. Some examples of common indexes are: LIBOR, PRIME, COFI, MTA, etc...Remember the margin stays the same but the index may fluctuate on a monthly basis. So when you refinance you can negotiate your margin and the index type. Once decided, the index type never changes.
Research the historical trends on the various ARM indices to see which tend to change less over time. Also, if your ARM is about to adjust after a fixed period, start watching the index so you'll have some idea what your new rate will be. If it will be too high, you may wish to consider refinancing before the adjustment date.
After choosing your index there are caps that are then put in place to make sure your rate cannot go past a certain point no matter what your index does. It should be known these caps are usually quite high.
The rate against which lenders quantify the differences between the present interest rate on an adjustable rate mortgage and that earned by other investments, which is then used to adjust the interest rate on an adjustable mortgage up or down.
When choosing an Adjustable Rate Mortgage (ARM), it is recommended to research on the underlying index. Some indices tend to adjust faster and more often than others. As a mortgagor, a less volatile index is most preferred.
While the index that you choose is very important to you there are also many other factors to consider when obtaining an ARM (Adjustable Rate Mortgage) loan. You must decide what kind of ARM loan you would like. Do you want an ARM that is fixed for 1 year, 3 years, 5 years 7 years, etc...? What are your plans for th property and what is the reasoning for financing the property? Do you just plan on keeping the house a couple of years and moving on? Are you just looking to reduce your payments for a couple of years to help you get control of your finances? These are all questions you should be asking yourself so that you are not only able to pick out the right ARM loan but the right index too.
The index you choose also should be determined by what type of market that you are in as well. If we are in an increasing market you may want to go with the MTA as it is a 12 month average of the LIBOR so it will always be lower in the increasing market and less volatile. While if we are in a decreasing market you may want to choose the LIBOR over the MTA because the LIBOR will lower more quickly than the MTA.
Remember the index always changes and your margin never changes. When taking a loan make sure you are comfortable with the volatility of the index.
PRIME is a actually short for the Federal Prime Lending Rate. It represents an interest rate in itself. The prime rate is also indexed, and used to determine the interest rate you will be charged when you apply for a Home Equity Line of Credit.
Indexes Explained - There are several indexes that a lender may use for your adjustable rate mortgage (ARM). Although lenders can choose from a variety of indexes for your ARM, most likely you will not be able to request a certain index.
The lender offers types of mortgage programs, that the secondary market has already agreed to purchase with a predetermined index.
LIBOR is a comon index that stands for the London Inter Bank Offering Rate. It is the average interest rate that London banks trade on deposits. Generally the LIBOR index is the most volitile, it can fluctuate the biggest amount and the most frequently.
Prime is an idex that is very widely used. The prime rate index is an index that is heavily used by credit card companies, second mortgage lenders, and home equity lines of credit among many others. The Prime rate is what you always hear about in the news going up and down, but most recently going a lot more up (3/1/06).
The COFI, or the 11th District Cost of Fund Index, is the average interest expenses incurred by member banks in the 11th Federal Home Loan Bank district. The 11th district refers to California, Arizona and Nevada. The interest expenses on deposits such as savings and checking accounts, CD's, money market accounts, etc. are reported by the member institutions.
The Cost of Deposits Index (CODI) is based on rates the bank pays on three-month certificates of deposits. It is characteristically slow to move both up and down.
MTA is the Monthly Treasury Average. This index averages the past 12 months average yields on U. S. Treasury securities. Since it is a 12 month average the index is more stable, slower to adjust and generally lags the market for both upward and downward trends.
COSI - cost of savings index. Similar to COFI except it is one particular Bank's own deposit accounts. The Bank borrows money from consumers in the form of deposits, i.e. C/D's, checking and savings accounts, and then lends the money out as home mortgages.
Your mortgage broker will be able to guide you with your decision of choosing the right index for your situation.
Prime Rate is another common index, especially for second mortgage HELOCs.
Fully Indexed Rate - The Fully Indexed rate is the total rate that a mortgage payment is based on. The fully indexed rate is equal to the margin plus the index.
The fully indexed rate is calculated based on the index, possible indexes could be Prime, LIBOR, COFI, MTA, etc..., plus the margin. The margin will remain constant (the same) for the life of the loan. However, the index is what will vary. An example would be a loan where you have Prime as your index, and Prime is currently 7.5%, and your margin is 2.5%, so your fully indexed rate would be 7.5 + 2.5 = 10.0%. If Prime happens to go down to 6.5% 1 year later, your fully indexed rate would change to 9.0%.
Most loans that offer a monthly payment of any amount less than the fully indexed rate, still require that the borrower qualifies for the loan, at what the payment would actually ben fully indexed.
Loans with an adjustable rate feature will adjust to the fully indexed rate when the fixed period has expired.
Always ask your lender what the fully indexed rate is on your particular loan. You may want to ask for historical data on what the index tied to your loan is based on.
A good example is an option arm. This has a completely different fully indexed rate than the rate you are making payments on. Also qualification is typically based on the fully indexed rate as opposed to the low 1% payments available.
When looking at the Fully-Indexed rates of Adjustable Rate Mortgages, always consider the volatility of the underlying indices. Because some indices tend to adjust faster and more often than others, a mortgage with the lower Fully Indexed rate today may not have the lowest in the long run.
