An adjustable rate mortgage is a variable loan which is referred to as ARM. When a loan is adjustable it means the interest rate can change over time and that will make your payment change on a month to month basis. It may adjust up or down depending on the market. Adjustable rates transfer the risk of rates changing from the lender to the borrower. The benefit is that if the rate falls and the loss is if the rate rises. Normally, if you get into an adjustable the overall rate starts lower than a fixed rate mortgage.
An adjustable has a margin and an index. The margin is the fixed portion of the rate and the index adjusts. There are different indices such as Libor and Prime which determine what the changes are and how much they change. Rates based on indicies are tied to many different factors such as the un-employment rate, the bond and stock market. The LIBOR for instance is the London Interbank Offered Rate, which is tied to the average rates offered at leading banks in London. The Prime rate is tied to federal reserve, it is approximately 3% higher than the federal funds rate. You may be thinking “My loan is tied to some market in another country?” YES. Welcome to international markets.
You do not get to choose which index you want when applying for a loan. The index is tied to the program. For example: if you were to take out an equity line of credit, which is adjustable, your index would most likely based on Prime. If you were to get a 5 year fixed mortgage, after 5 years your loan would begin to adjust, your index would be LIBOR. This is why our clients have us shop around their loans to many different sources of funding.
Back in the day when World Savings was around, (the best savings and loan bank I have ever seen) they offered the most stable and safe indices and they allowed you to choose such as COSI, COFI and CODI. COSI, the cost of savings index, was the average of monthly savings rate offered. COFI, the cost of funds index, was the regional average of interest expenses incurred by financial institutions. CODI, the certificate of deposit index, was the average CD rate. World offered very safe indices that the loan could be tied to. There have been a lot has changes over the past decade. Savings and loan institutions seem not to exist for the most part. The only thing constant is change and the mortgage industry is constantly changing. I am always updating myself on all the changes so I can offer the best cutting edge programs, advise and service. If you are getting an adjustable loan do some research on the index that your loan will be tied to, that way you will have a better idea how your loan will perform for you.
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