Sos Roofline Systems

In addition to the many 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).

When we speak about the index for the ARM, we are talking about the instrument that the adjustments to the mortgage rate will be tied to. Various indices are used, including government treasury instruments, the Fed Fund rate or LIBOR.

The rate on an ARM is adjusted periodically upwards, or downwards, based upon the movement in the general interest rate market, but tied to a specific instrument. If your ARM is tied to the CD rate, and the bank’s CD rate increases, your interest rate will likewise go up. ARMS also contain adjustment caps, so that you can limit the exposure as to how high your mortgage rate can go, even if your index rate continues to go up, which is good if you just had an adjustment, and the rates increase again. This can be a disadvantage if you have just readjusted, and then there is a downward movement, however.

ARMs can be tied to any number underlying instruments, such as the 90 day U.S. Treasury Bill. Another basis that is frequently used is the Federal Funds Rate. LIBOR, the London Interbank Offered Rate, is a very popular index, and is the rate used by international companies to borrow.

How you decide upon the correct index is dependent upon your particular circumstances and how you believe interest rates will move. If you have an ARM that uses CDs as its index, you can expect it to be very responsive to market moves. On the other hand, if your ARM is based on T Bills, it will move more slowly. Fastest of all in reaction time is the LIBOR, so if you feel that rates are falling and want to take advantage of every downward move, this is the one for you.

An interesting, and possibly dangerous choice in interest rate options is the option ARM, which permits the borrower to pick the “option” of choosing his mortgage payment each month. 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. There is a real danger in option mortgages that the loan will end up with negative amortization, which means the mortgage balance increases instead of decreasing as it normally would.

With all of these choices, a potential borrower should be sure to talk to a professional mortgage consultant who understands the various products and can help you choose the best one for you.