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This is the first definition in a series of “Real Estate ABCs.” Our goal here is to help you understand the basics of real estate like the different mortgage types and what some of the scarier terms mean.
According to realtor.com adjustable-rate mortgages (ARMs) are home loans that have variable interest rates. This means that as the market interest rates fluctuate, your interest rate and monthly payment will move up or down. Lenders will generally start the ARM interest rate LOW for a fixed amount of time to get you to take the risk. For example, a 1-year ARM means that after 1 year your interest rate and payment will be adjusted.
The new standard is the “5/1 ARM.” Your initial rate lasts for 5 years but is adjusted every year following the first 5 years. This is also called a “hybrid ARM.” The rate fluctuates according to an index (explained below) that is spelled out in your closing documents. There are 3 major indexes:
- “Weekly constant maturity yield on the 1-year Treasury Bill – The yield debt securities issued by the U.S. Treasury are paying, as tracked by the Federal Reserve Board.
- “11th District Cost of Funds Index (COFI) – The interest financial institutions in the western U.S. are paying on deposits they hold.
- “London Interbank Offered Rate (LIBOR) – The rate most international banks are charging each other on large loans” (realtor.com).
- Periodic rate cap – typically an annual cap that prevent your rate from rising more than a specified number of % points per year.
- Lifetime cap – over the life of the loan, the interest rate may not rise over a certain limit.
- Payment cap – over the life of the loan, the monthly payment (rather than the interest rate) may not rise above a certain dollar amount.
- Is the ARM convertible to a fixed-rate mortgage?
- Is the ARM assumable? (i.e., when you sell your home the buyer may qualify to take over your mortgage.)
Last but not least, keep an eye on Bankrate.com. They track and compare various types of loans.