ADJUSTABLE RATE MORTGAGES (ARM )

OVERVIEW:

There are many adjustable rate  mortgages (Monthly, 6 Month, 1 year, 2 year, 3 year, 5 year, and 7 year).  The most common is the 1-year ARM .  The 1-year ARM will start off at a discounted rate (a rate that is much lower than the going 30 year fixed).

The one-year (1) ARM  can increase or decrease at a maximum of 2% per year and in most cases never exceed 6% above the initial note rate . 

A (6) month ARM  will adjust by 1% every six months and never exceed 6% above the initial note rate . 

Getting back to the one-year 2% annual and 6% lifetime maximum's...These maximum's are called "caps".  They are annual for one year ARMs and semi annual for 6 month ARMs.  The lifetime is 6%, meaning that the rate  can not exceed 6% of the note rate.

For example: an adjustable that starts off at 5% can never exceed 11% (6% above).

The 2% (or 1%) per adjustment, means that the rate  can adjust up or down by a maximum of 2% at the adjustment date.  An adjustable that starts off at 5% can not exceed 7% (regardless of the market condition) for the adjustment.  This rate will vary from adjustment to adjustment until the end of the 30-year term .  The rate can continue up (to the 6% maximum) or down, or the rate will remain constant.  Chances are very good that your first adjustment will be "up."

Don't be fooled by the low "start" rate .  That "start" rate is not the real rate.  The real rate is the "Fully Indexed Rate."  The ARM 's adjustment is determined by the "INDEX" (the rate the bank buys it at), plus the "MARGIN" (this is the banks profit).  The INDEX + MARGIN = the actual rate.

If you financed an ARM  at 5% and the market didn't move in the next year, your rate  would "increase."  The index  is usually based on the 1 year Treasury bill (T-Bill).  Assume that the T-Bill at the time of application was 4.5%.  That's a nice rate, but the bank wouldn't make any money unless they attach a "margin " (profit).  Most "margins" are 2.75% above the note rate.  The "Fully Indexed Rate" is 7.25% (4.5 + 2.75), which means the "true" rate is 7.25%. 

If the market stays the same and the start rate  is 5%, the "true" rate is 7.25%.  At the adjustment period in one year, the ARM  will "increase" to 7% (2% per year max.).  If the market continued to remain steady for the next year the rate would increase again (another .25%) to top out at the "Fully Indexed Rate" of 7.25%. 

Imagine what would happen to the rate  if the market moved up slightly.  That 5% would increase quite a bit in a short period of time.  Now you know how an Adjustable Rate Mortgage  (ARM ) works.  ARM’s are good if the market is on a downward trend.

Convertible ARMS

Some ARMs can be converted to Fixed Rates , usually between the 1st and 5th year.  At the time of the conversion, the rate  will usually be .625 (5/8%) higher than the FNMA  60 day average and the conversion fee is $250.  Sometimes an additional 1/8 or 1/4% is added to the initial note rate.  See the Matrix to determine which lenders have the convertible option.

3/1, 5/1, 7/1, 10/1 ARMs

These Adjustables initially remain "fixed" for specified years (3,5,7 etc.), then automatically convert to a one "1" year adjustable with 2 & 6 caps for the remaining loan term .   At initial rate  change the rate can not go higher than 3 or 4%, then at the next change (next year) the CAP will be 2%.

3/3 ARM

This Adjustable adjusts every 3 years for the loan term  (usually 30 years).  The caps are different for each lender.  The margin  varies and the caps are usually 2 & 6.

                  NOTE:  US Treasury securities (T-Bills) are listed in the Wall Street Journal.

6 MONTH LIBOR

This is another type of adjustable that changes every 6 months and is based on the

London Inter Bank Offered Rate for U.S. dollar deposits as published in the Wall Street Journal.  CAPS are 1/6.  This loan can adjust up or down by 1% every 6 months and can not exceed 6% above the initial start rate.  Qualify the borrower at 1% above the start rate , unless otherwise indicated.  Check the Matrix and lender specs for more information.

To qualify (in most cases) for an adjustable the following applies:  (28/36 ratios )

LTV  under 75%...Qualify at the Note rate  or 7%, whichever is higher. 

LTV  over 75%...Qualify at the Note rate  + 2% or 7%, whichever is higher.

Licensed Mortgage Banker - New Jersey Department of Banking and Insurance; Licensed by the Pennsylvania Department of Banking; Virginia Licensed Mortgage Lender