Not all ARMs are created equal...

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Adjustables offer introductory rates, which are currently in the range of 3.95%-8%. These introductory or teaser rates typically last from 1-12 months. While these may offer enticing short-term savings, it is important to factor this in to your total estimated interest cost over the time horizon you expect to keep the loan. To estimate the interest cost, you should consider….

The index is the reference point used to periodically reset the rate. The (5) most common indices are: the 12- Month Treasury Average (12MAT), Eleventh District Cost of Funds (COFI), 1 -Year Treasury, 6- Month Certificate of Deposit and 6- Month LIBOR. Click here for a graph of these indices. While these are all positively correlated, they do vary in rate and stability. The COFI and 12 MAT are the most stable. Since 1989, the COFI has never increased or decreased by more than 2% in any 12-month period. The 12 MAT did increase more than 2% but only once- during the period 1Q’94- 1Q’95. However, during this period, interest rates increased at the fastest rate since World War II, with the Federal Reserve raising rates 6 times. Since the rates for adjustables are reset based on the index value on a particular day, index stability will enable you to avoid an unpleasant surprise. Thus, our preference is the 12 MAT or COFI.

Margin

Margin is the spread that is added to the index value to periodically re-set the rate. This is expressed as a percentage and can range from -5% to 7% with the majority falling between 2%-3%. All else equal, the lower the margin, the lower the total interest over the life of the loan. Note, the difference between a 2% vs. 3% margin translates into savings of 1% per year of your loan balance. Also, the lower the start rate usually the higher the margin. Since the introductory rate on adjustables lapse within 1 year but margin remains constant throughout the life of the loan, watch the margin.

Fully Indexed Rate

This is the sum of index value and margin. Index values are expressed as a percentage. For example 5%, 6% etc… Thus, if the index value is 5% and the margin is 2%, the fully index rate would be 7%.

Adjustment frequency

Adjustables call for periodic rate adjustments. These can be monthly, quarterly, semi-annually, and annually.

Periodic rate cap

This is the maximum amount the rate can change between adjustment periods. Adjustables which call for monthly adjustments usually do not have a period rate cap. This is unlikely to pose significant interest rate risk if the adjustable is tied to the 12 MAT or COFI given the stability of the indices (click here to view a graph   However, it would be wise to make sure that an adjustable tied to the LIBOR, 1-Year Treasury, or the Six Month Certificate of Deposit Indices do have a periodic rate cap, as these indices can move quite quickly. Also, make sure not to confuse a period rate cap with an….

Annual Payment cap

Adjustables with monthly rate adjustments feature an annual payment cap. This is usually limited to 7.5% above the minimum monthly payments for the previous year. For example, if your minimum payments during year 1 are $2,500, your minimum payments during year 2 would be: $2,500 x 1.075%=$2,687. This feature works in conjunction with…

Deferred interest payments

Known as minimum payments, this feature calls for payments which are less than that required to pay off the loan off in equal monthly installments. The difference between these payments is added to the loan balance. This is known as negative amortization or interest accrual. Negative amortization is allowed until the earlier of: a) loan balance equaling 110% to 125% of original loan amount or; b) 5 years lapsing from loan origination. Deferred interest payments are typically based on a very low start rates (usually 3.95%- 6%) and are adjusted upward annually for years 2-5. This option can be a smart financial planning device as it provides an opportunity to minimize your payments and use the savings to pay down higher interest rate debts and leverage your rate of return.

 Many of our Adjustables feature…

• no points and/or no closing costs

• start rates as low as 3.95% for very low payments

• margins as low as 2% designed to save you money over the years

• Interest only and deferred interest payments