Adjustable Rate Mortgage - How They Work?
By Martin Luka
does an ARM work.
borrowers interest rate is determined initially by the cost of
money and the time the loan is made. Once the rate has been set,
and it is tied to one of several widely recognized and published
indexes , and future interest adjustments are based on the upward
an downward movements of the index. An index is a statistical
report that is generally reliable indicator of the approximate
change in the cost of money.
the time a loan is made, the index preferred by the lender is
selected, and thereafter the loan interest rate to rise and fall
with the rates reported by the index. Since the index is a reflection
of the lenders cost of money, it is necessary to add a margin
to the index to ensure sufficient income for administrative expenses
and profit. Margin will usually vary from 2% to 3%. The index
plus the margin equals the adjustable interest rate. It is the
index rate that fluctuates during the term of the loan and the
cause of the borrowers interest rate to increase and decrease,
the lenders margin remains constant.
lenders try to use an index to is very responsive to economic
fluctuations. Some of the indexes are Treasury Rates--CMT-MTA-COFI-CODI-COSI-LIBOR-Prime
margin is the difference between the index rate and the interest
charged to the borrower.
- current index rate
- mortgage interest rate (note rate)
rate adjustment period refers to the intervals and which a borrowers
interest rate is adjusted, example: six months, one year, for
years and so on. After referring to the rates movement in the
selected index, the lender will notify the borrower of any rate
increase or decrease. Annual rate adjustments are most common.
used two different mechanisms to limit the magnitude off payment
changes that occur with interest rate adjustments: Interest rate
caps and payment caps
interest rate cap.
consumers are concerned with a phenomenon called payment shock.
Payment shock results from increase in the borrowers monthly payments
which, depending upon the amount and frequency of payment increases,
as well as the borrowers income, may eliminate the borrower's
ability to continue making mortgage payments.
Caps. This is a limit on the amount or percentage that a payment
may change at each adjustment. If this cap was 7.50% and your
monthly payment was $800.00, the most your payment could increase
would be $60.00 - to $860.00. At the next adjustment, the most
your payment could increase would be $64.50 (7.50% of $860.00
- for a $924.50 payment this period).
lenders discovered residential adjustable-rate mortgage instrument
in late 1979, recognize an opportunity to increase earnings. As
public acceptance of adjustable-rate mortgages grew, so did the
competition for adjustable-rate mortgage loans. To compete, lenders
lowered the first-year interest rates on the loans they offered
and introduce borrowers to discounts and buy-downs. The low initial
rate have subsequently been dumped teaser rates. Many lenders
offered attractive teaser rates merely to enlarge their portfolio
of adjustable-rate mortgages. But since most adjustable-rate mortgages
where he got interest rate caps prior to 1984, there are many
instances where initial interest rates were increased by five
to six percent. Clearly a crisis was developing.
protect borrowers from payment shock and perfect lenders from
portfolio shock, lenders began imposing caps on their adjustable-rate
Mae and Freddie Mac caps.
Fannie Mae and Freddie Mac have guidelines relating to adjustable-rate
mortgages interest rate caps. There are many different adjustable-rate
mortgage plans, but as a general guideline, most adjustable-rate
mortgages purchase by Fannie Mae are limited to the rate increase
often no more than 2% per year and 5% over the life of the loan.
Freddie Mac rate adjustment guidelines limiting rate increase
to 2% per year and 5% over the life of the loan.
payment adjustment period. The mortgage payment adjustment period
defines the intervals and reach a borrower's actual principal
and interest payments are charged.
are two ways the rate and payment adjustments can be handled:
lender can adjust the rate periodically as called for in the loan
agreement and then adjust to mortgage payment to reflect the rate
change. The lender can adjust the rate of more frequently than
the mortgage payment is adjusted. For example, the loan agreement
may call for interest rate adjustments every six months but changes
in mortgage payments every three years.
a borrower's principal and interest payment remains constant over
a three-year period by the loans interest rate has steadily increased
or decreased during that time, than to little or too much interest
will have been paid in the interim. When this happens, the difference
is subtracted from or added to the loan balance. When unpaid interest
is added to loan balance, it is called negative amortization.
Lukac, represents, #1 Loans USA(http://www.1LoansUSA.com),
a finance web-company specializing in real estate/mortgage market.
We specialize in daily updates, rate predictions, mortgage rates
and more: info@1LoansUSA.com