Learn The Truth About ARMs

In addition to the many decisions you have to make when you are choosing a mortgage, 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 of the "index", we are speaking of the base financial instrument that the changing rates will be based on. Indices can include the CD rate, the Treasury Bill rate, the Fed Funds rate, the LIBOR rate and, the new kid on the block, the options ARM.

The basic idea of an ARM is that the interest on the loan is adjusted up or down, on a periodic basis, based on a chosen underlying interest rate that is indicative of interest rates in general. One such instrument would be Certificates of Deposit-your mortgage rate would go up and down with the CD rate. ARMs have rate adjustment caps, so that the rate on your mortgage will only go up at certain intervals (every three or six months, for example), so that if the CD rate goes up, you may not have an increased rate for a few months, if your rate just adjusted recently. Of course, the reverse can happen, and if your rate has just been readjusted at a high rate, and then the index moves down, you will not be able to take advantage of that until your next readjustment period.

Your ARM may be tied to the Treasury Bill rate, which is the rate the United States Government pays on its 90 day investments. The Fed Funds interest is the most used index for ARMs. LIBOR is the London Interbank Offered rate, which is a rate that commercial borrowers pay each other for the use of funds.

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 should choose the CD rate as your benchmark. On the other hand, if your ARM is based on T Bills, it will react 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.

But in addition to these standards, new products are always been put on the market; an example would be the option ARM, which lets a borrower decide how much mortgage he is going to pay each month! Of course, there is a minimum, usually the amount of interest, so the bank can guarantee its return, and then the balance goes toward the loan. One of the big issues with an option mortgage is that you can end up with an increasing instead of decreasing mortgage; this is also called as negative amortization.

There are so many choices in the home mortgage market today that the new home buyer should not attempt to cover this field by himself but should instead call a certified mortgage consultant.