How Is The Rate Of Your Arm Calculated In Mortgage Loan
Whenever you are looking for mortgage loan, the critical factors that influence your
decision can be the term of the loan and the rate at which you will get the loan. Risk tolerance is a really big factor here. Some people may not be able to sleep at night if they know their mortgage payment might go up. So theyre good candidates for a fixed rate on their mortgage loan. But the economists say that 80 to 85% of the time many borrowers come out ahead with adjustable rate mortgage (ARM). Here we discuss what ARM is and how the benchmark interest rates set by various financial regulatory bodies influence the rates of your ARM.
An ARM generally starts with a low interest rate, up to 3% lower than a fixed rate mortgage. With lower rates, you usually qualify to borrow more than with a fixed rate home loan. ARMs usually start with a fixed rate of interest period and end with fluctuating yearly interest rates, increasing or decreasing your monthly payments. Different types of ARM loans will have varying affects on the monthly mortgage payment, as well as would affect the interest rate and loan principal. There are two common types of adjustable rate mortgages (ARM), the Hybrid and the Interest Only.
A Hybrid ARM is kind of like a combination of a fixed rate and an adjustable rate mortgage. The interest rate stays fixed for a predetermined amount of years at the beginning of the loan. After the initial fixed rate period is over, the remainder of the loan has an interest rate that periodically adjusts to the market rates. So a 3/1 ARM means 3 years of fixed rates with interest rates changing every year after that. On the other hand, an Interest Only ARM allows for a low monthly payment at the beginning of the loan. The number of years where only interest is paid can vary and is generally between 3 and 10 years. After the interest only period ends, the homeowner will start to pay back the principal at a higher rate than a normal fixed rate mortgage.
To better understand how the interest rate is calculated, you can get in touch with your
mortgage loan help provider. In the mean time, here is some information that will give you a head start.
The interest rate on all ARM loans is calculated on the basis of an index rate. The most popular ARM indices are Cost of Funds Index (COFI), London Inter Bank Offered Rate (LIBOR) and Constant Maturity Treasury (CMT). Adjustable rate loans are tied to an economical index that can rise or fall, change faster or slower. Even though there are no better or worse ARM indices, they all have slightly different features. Some ARM indices are more volatile, others are more stable. Also, some have lower values, and others are significantly higher. However, the difference between COFI, LIBOR and CMT are compensated by lenders who use lower margins on higher value indices, and higher margins on lower indices. In other words, banks use the index rate as a baseline, and add an additional fixed amount, called the margin, to calculate the interest rate that will be charged on your loan.
If the lender is offering a LIBOR ARM and they use a 3% margin, the ARM will have a fully indexed rate of LIBOR + 3%. The margin of the
adjustable rate mortgage (ARM) does not change throughout the life of the loan. However, they often start with a lower rate for limited time.
For example, if the fully indexed rate of your ARM is 6.75% (LIBOR + 3%), your start rate may be 2% lower (4.75%) for 3 years. Once the fixed period expires, your rate will be adjusted to reach the fully indexed rate, or according to the value of the LIBOR index and within the adjustment and lifetime caps of the loan.
You are advised to carefully review you loan agreement to make sure you fully understand how your interest rate will be calculated.
by: Ask Bill
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