All About Adjustable Rate Mortgages

What is an Adjustable Rate Mortgage?
An Adjustable Rate Mortgage (ARM) is a mortgage in which the interest rate is adjusted periodically based on a pre-selected index.

Characteristics of an ARM
Index – An index is a published interest rate against which lenders measure the difference between the current interest rate on an adjustable rate mortgage and that earned by other investments (ex. 5 year U. S. Treasury yields, 6 month LIBOR, and the 11th District cost-of-funds index, or COFI). The index is then used to adjust the interest rate up or down.

Margin – The margin is the percentage a lender adds to the index to establish the adjusted interest rate.

Adjustment Date – The adjustment date is the date that the interest rate changes.

Adjustment Interval – The adjustment interval is the time between changes in the interest rate and monthly mortgage payment.

Interest Rate Caps – Interest rate caps are consumer safeguards that limit the amount of change to the interest rate. Caps assure the borrower that financing costs will not rise excessively if there is a sharp increase in interest rates.

Start Rate (also know as initial interest rate) – The start rate is the interest rate of the mortgage at the time of closing. This rate will change at the adjustment intervals based on the index, margin, caps, and floor rate.

Floor Rate – The floor rate is the minimum rate that the mortgage could ever achieve regardless of the caps. The floor protects the lender from a sharp decrease in rates.


For the following definitions we will use the adjustable rate mortgage example below:
5/1 ARM with caps of 5/2/5

This ARM will have a start rate that will be fixed for the first five years of the loan term (5/1 ARM with caps of 5/2/5). The 1 (5/1 ARM with caps of 5/2/5) means that it will adjust once per year (see adjustment interval definition above) after the initial fixed period.

Initial Interest Rate Cap (5/1 ARM with caps of 5/2/5) - The maximum percentage that an interest rate can change during the first adjustment. In the example above, the interest rate can increase or decrease a maximum of 5% in the first adjustment, subject to the floor rate (see floor rate definition above).

Periodic Interest Rate Caps (5/1 ARM with caps of 5/2/5) – The maximum percentage that an interest rate can change during each adjustment after the first. In the example above, the interest rate can increase or decrease a maximum of 2% for each adjustment after the first, subject to the floor rate.

Lifetime Interest Rate Caps (5/1 ARM with caps of 5/2/5) – The maximum percentage that an interest rate can change during the life of the loan. In the example above, the interest rate can increase or decrease a maximum of 5% throughout the entire life of the loan, subject to the floor rate.


When is an Adjustable Rate Mortgage a Good Idea?
An ARM is not for everybody. However, in certain cases choosing an ARM over a fixed rate mortgage can save the borrower thousands of dollars in interest charges. For borrowers who feel they will own their home for a relatively short period of time, an ARM can be a perfect solution. Many ARMs come with a fixed period of 3, 5, 7, or 10 years. If the borrower will be living in the home for less than any of these terms, they will not be subject to any rate adjustements. Therefore, by choosing an ARM, they will typically save on interest payments due to the fact that ARMs typically come with lower interest rates than FRMs. It might also make sense to choose an ARM when economic conditions indicate that interest rates will be decreasing in the future. This can be a risky strategy and it is best to discuss this with your loan officer prior to making a final decision.

Check out the resources on http://www.noblelenders.com/ to learn more about financing options.

Fannie Mae to the Rescue!

Fannie Mae has just announced another initiative to aid in recovery from the subprime mortgage crisis. This initiative will be fairly limited in scope but will address a group of homeowners that haven’t received much help to date. The new program aims to assist homeowners that are upside down on their homes, or in other words those that owe more on their mortgage than their home is currently worth. Without this recent announcement, some of these homeowners would be forced to bring money to the closing table in order to refinance their existing mortgage or sell their home given the current market conditions.

The Nuts and Bolts of the Program

There are clearly benefits in this program for both homeowners and Fannie Mae. Under it, homeowners will not be forgiven of any debt but will have the opportunity to refinance at a mortgage balance of up to 120% of the value of the home. This may result in relief to the homeowner by reducing interest rates, converting an adjustable rate mortgage (ARM) to a fixed rate mortgage (FRM), and/or extending the repayment term. Fannie Mae is banking on the idea that this will help homeowners avoid falling behind on their mortgage and buy them some time to allow home values to stabilize and begin appreciating again. The benefit for Fannie Mae is that by keeping these mortgages current, they can avoid or postpone writing down further losses associated with delinquent mortgages.

What does it take to qualify?

Again, this program will allow for loan-to-value ratios of up to 120%. The major stipulation is that the mortgage must be paid current and Fannie Mae must either own or insure the mortgage.

FHA Secure vs. New Fannie Program

So what is the difference between this program and FHA Secure? FHA Secure is an excellent program that allows homeowners that are current or delinquent on their ARM to refinance. If the borrower is delinquent, they must show proof that the delinquency was caused by an increase in mortgage payments caused by the reset of an ARM. The borrower may have an FHA or non - FHA mortgage and still be eligible for refinance. However, the current mortgage must be an ARM. With Fannie Mae’s new initiative, the borrower may have an ARM or FRM but they must be current and must have a Fannie Mae owned or insured mortgage. Both programs do require borrowers to meet traditional underwriting guidelines for income, assets, employment, etc.

To learn more about this program, click on the red drop down banner at the top right corner of the http://www.noblelenders.com homepage.

Adjustable Rate Mortgages - LIBOR is on the Way Up!

The LIBOR has been rising in recent weeks begging the question: How does LIBOR affect the American homeowner?

LIBOR stands for the London Interbank Offered Rate and it is the interest rate at which British banks borrower funds from one another in the London wholesale money market. Many adjustable rate mortgages are based on LIBOR. An adjustable rate mortgage (ARM) is a mortgage in which the interest rate is adjusted periodically based on a pre-selected index. Probably the most common index is the 6 month or 12 month LIBOR. A popular ARM mortgage product is the 5/1 ARM. What this means is that the loan is fixed for a period of 5 years. After that time, the rate begins to adjust based on the current LIBOR index. When LIBOR is rising and your loan is in the adjustment period, your rate will go up regardless of whether or not mortgage interest rates are down.

So, why is LIBOR rising?

In recent months the Federal Reserve has embarked on an aggressive interest rate cutting campaign. This has caused the gap between LIBOR and the interest rates set by central banks to increase. Many believe this is a sign that banks are in poor financial health and are reluctant to lend money. This seems logical considering much of this mortgage crisis is due to a lack of liquidity in the secondary mortgage market.

What does this mean to homeowners?

If you currently have a fixed rate mortgage, it means nothing. However, if you have an adjustable rate mortgage that is scheduled to begin adjusting in the next 18 months, now may be a great time to take action. This might be an excellent time to consider a refinance. Of course, remember to explore all options before making a decision to refinance. Ask yourself questions like: How long will you be in this home? How long until you plan to retire? Do you have catching up to do on your retirement savings? Are you preparing to send children to college? Do you currently have equity in your home? Is there a pre-payment penalty on your existing mortgage?
With interest rates near historical lows, this could be a great time to refinance. Just make sure to ask questions and determine if it’s right for you.

Also, check out the refinance calculators at http://noblelenders.com/calculators.php for additional guidance.

Relief could be on the way!

The Federal Deposit Insurance Corporation has proposed a new plan that could help a large number of borrowers in the United States that are dealing with declining property values. The plan is specifically aimed at homeowners whose mortgage balance is currently higher than their property value, thus putting them "upside down". Under the new plan, the United States Treasury Department would issue loans to borrowers that would allow them to pay off some principal and restructure their mortgages. This could work wonders for over 1 million homeowners. Many homeowners aren't currently able to refinance their adjustable rate mortgage because they don't have the equity to do so. In the very recent past, loans have been written based on very high loan-to-value ratios. Now that underwriting guidelines have tightened and property values have declined, many borrowers are unable to qualify to refinance out of their adjustable rate and into a fixed rate mortgage. This is probably the most logical proposal that I have seen during the current mortgage crisis. I sincerely hope this proposal gets the approval of our Congress.
For a definition of any terms in this blog that you may be unfamiliar with, click here http://www.noblelenders.com/glossary.php