In addition to all of the other decisions you have to make when you are choosing a home loan, such as whether to go fixed or floating rate, how much down payment to make and how many points to pay, lenders have further complicated everything by offering a wide range of choice of indexes for ARMs (adjustable rate mortgages).
The index is the underlying instrument that is used as a basis for the adjustment of the mortgage rate. Various indices are employed, including government treasury instruments, the Fed Fund rate or LIBOR.
The basic concept of an ARM is that the interest on the loan is adjusted up or down, on a periodic basis, based on a chosen underlying interest rate that is indicative of interest rates in general. If your ARM is tied to the CD rate, and the bank’s CD rate increases, your interest rate will likewise go up. ARMs have rate adjustment caps, so that the rate on your home loan will only go up at certain intervals (every three or six months, for example), so that when the CD rate goes up, you may not have an increased rate for a few months, if your rate just adjusted recently. But be aw are, however, that if you just readjusted at a higher rate, and your index rate goes down, you are stuck with the higher rate until the next adjustment period.
ARMs can be tied to any number underlying instruments, for example the 90 day U.S. Treasury Bill. The Fed Fund rate is the rate banks pay to the Federal Reserve Bank for funds. LIBOR, the London Interbank Offered Rate, is another popular index, and is the rate used by international companies to borrow.
Which is the right choice depends on your own circumstances and your view of where interest rates are heading. Adjustable rate mortgages that use CDs as the reference rate tend to change more quickly. Adjustable rate mortgages that use T Bills will change more slowly. LIBOR is the index that moves the most frequently and the most rapidly, so if you want to take frequent advantage of the downward level of lowering rates, this is the one for you.
As we said, new products are introduced each day, and one of the newest it the option ARM, which allows the borrower to choose how much he wants to pay on his home loan each month. The options that are offered are interest-only payments, and a lowest possible payment that can’t be less than the interest-only payment. There is a real danger in option mortgages that the loan will end up with negative amortization, which means the mortgage balance goes up instead of decreasing as it normally would.
This is a lot of information for the borrower to digest, and the best solution is to talk to a professional mortgage broker who can explain it all and recommend the best solution for you.
Contact us at pret hypothecaire and courtier hypothecaire
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