Worrying about what kind of mortgage you want to take is difficult enough, without having to decide on which interest rate index is going to be the deciding factor on what your interest rates on your Adjustable Rate home loan will be!
When we talk about the index for the ARM, we are talking about the instrument that the adjustments to the loan rate will be tied to. Indices used include the CD rate, the Treasury Bill rate, the Fed Funds rate, the LIBOR rate and, the newest.
You must initially understand that an ARM is a mortgage with an interest rate that moves up or down within a certain set period, and the movements are predicated upon the movements of the underlying index. If your index is CDs, and CDs go up, your interest rate goes up. ARMS also contain adjustment caps, so that you can limit your exposure as to how high your loan rate can go, even if your index rate continues to increase, which is good if you just had a change, and the rates increase again. By the same token, if your adjustment is scheduled to take place immediately after the CD rate increased, you will have that rate for a while, even if the CD rate is lowered in the interim.
There are a large number of ARM indices, including the CDs, LIBOR and government bonds mentioned. The Fed Funds rate is another very popular basis for ARMs. Another popular index used by a lot of lenders is the LIBOR, or the London Interbank Offered Rate, which well rated international companies pay to borrow.
The index is a personal choice, based on the individual loan, and how the borrower feels interest rates will be heading. If you would like a rate that is responsive to the interest rate market, you would choose the CD rate as your benchmark. Rates on Treasury instruments such as the Treasury Bill move more slowly than CDs, and so will react more slowly to interest rate changes. LIBOR is the index that moves the most often and the most rapidly, so if you want to take frequent advantage of the downward level of decreasing rates, this is the index for you.
An option ARM is one where the interest rate adjusts monthly and the payment adjusts annually, and the borrower is offered an “option” on how large a payment he wants to make. The mechanism behind these loans is that they are interest interest only loans, so you have to pay that minimum, and then you can choose to pay more. Be warned that minimum payment option can end up in an increasing, rather than decreasing mortgage, a phenomenon known as negative amortization.
With all of these choices, a potential borrower should really talk to a professional mortgage broker who understands the various products and can help you choose the best one for you.
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