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Is an Adjustable Rate Mortgage (ARM) for you?

 What is an ARM or adjustable-rate mortgage? 

An adjustable-rate mortgage, or ARM, is the most misunderstood loan for most people, including those entering the mortgage profession. There are hybrid versions of the ARM that are no longer insurable today after the 2008 financial crisis. The hybrid ARM with interest-only option falls into the non-qualified mortgage product. I will only discuss the ARM loans that are currently available as an insurable qualified mortgage. 


The benefit of an ARM for borrowers is the lower rates and payments early in the loan term. Lenders can use the lower ARM payment for loan qualification resulting in a higher loan amount. 


Another benefit of an ARM is that more of your payment is applied to the loan principal compared to a fixed-rate mortgage. A fixed-rate mortgage amortized over 30-years has the majority of the interest in the front of the loan amortization schedule. An ARM recasts the loan with each payment, thereby applying more of your payment to the principle. 


ARM's can be great for homeowners and investors when there is a strategy to sell or refinance within five years. Lower monthly payments mean fewer out-of-pocket expenses and an increase in your ROI. There are ARMS available with up to 10 years of a fixed introductory period for conservative buyers.


The most popular ARM is the 5/1 ARM. The first number indicates that the introductory rate is fixed for five years, then adjusting once every year after. When two numbers are used the first number represents the fixed or teaser rate period, and the second number represents the adjustment intervals.


The initial cap, caps on subsequent adjustments, and lifetime caps are shown as three numbers. 5/2/5 means that after the first five years of the loan, the rate can't decrease by more than five percent above or below the introductory rate. For each year thereafter, the rate can't fluctuate more than two percent. 


Calculating caps correctly can be challenging. I highly recommend viewing the following professional training video provided by the late Atricia Woods, Founder of Affinity Mortgage Trainers. Click on her image to see her presentation on ARM's. Grab a paper and a pen, and get ready to take plenty of notes. 

Artricia Lynnette Woods
January 20, 1967 ~ October 23, 2020 (age 53)

I would like to dedicate my blog page to Atricia. She loved her work and people. She is missed by many.




Commonly Used Indices for ARMs


6-Month CD Rate

This index is the weekly average of secondary market interest rates on 6-month negotiable Certificates of Deposit. The interest rate on six-month CD indexed ARM loans is usually adjusted every six months. 


1-year T-Bill

This index is the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of 1 year. 


3-year T-Note

This index is the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of three years. This index is used on 3/3 ARM loans. The interest rate is adjusted every three years on such loans. This type of loan program is good for those who like fewer interest rate adjustments. The index changes every week and can be volatile.


5-year T-Note

This index is the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of 5 years. This index is used on 5/5 ARM loans. The interest rate is adjusted every five years on such loans. 


Prime

The prime rate is the rate that banks charge their most credit-worthy customers for loans. The Prime Rate, as reported by the Federal Reserve, is the prime rate charged by the majority of large banks. 


12 Moving Average of 1-year T-Bill

Twelve-month moving average of the average monthly yield on U.S. Treasury securities (adjusted to a constant maturity of one year.). 


Cost of Funds Index (COFI) - National

This COFI index is the monthly median cost of funds: interest (dividends) paid or accrued on deposits. 


Cost of Funds Index (COFI) - 11th District

This index is the weighted-average interest rate paid by 11th Federal Home Loan Bank District savings institutions for savings and checking accounts, advances from the FHLB, and other sources of funds. 


LIBOR

L.I.B.O.R stands for the London Interbank Offered Rate, the interest rates that banks charge each other for overseas deposits of U.S. dollars. These rates are available in 1, 3, 6, and 12-month terms. 



Would you consider an ARM for your purchase or refinance? 


Please post a reply or contact Mac to discuss your loan scenario and answer any questions you may have. 

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