"Mortgage ARM Indexes Explained" 

The index the adjustable rate mortgage is written against, is one of the most important factors to consider when choosing n adjustable loan program, as rate is tied to an index which will have an impact on your payment after the fixed period. In years past, an adjustable rate mortgage was usually tied to the 1-year constant maturity treasury index. Today, loans are available which are tied to many other indexes such as:

Other Features of Adjustable Rate Mortgages (ARM)

Limitations on Charges (caps)

Any mortgage where payments made by the borrower may increase over time brings with it the risk of financial hardship to the borrower. To limit this risk, limitations on charges, known as caps in the industry, are a common feature of adjustable rate mortgages. Caps typically apply to three characteristics of the mortgage:

For example, a given ARM might have the following caps:

Caps on the periodic change in interest rate may be broken up into one limit on the first periodic change and a separate limit on subsequent periodic change, for example 3% on the initial adjustment and 2% on subsequent adjustments.

Information About Caps

Loan caps provide payment protection against payment shock. Most First Mortgage loans have a 5% or 6% "Life Cap".

First Lien Caps
Most First Mortgage loans have a 5% or 6% Life Cap. If the adjustment period is 6 months or 1 year ( the two most common periods on the market), then it takes anywhere from 2-4 maximum upward adjustments to reach this cap.

Negative Amortization ARM Caps
Most of them are Monthly Adjustable ARMs and the life cap or ceiling is simply expressed as a maximum rate, usually 9.95% or 10.95% these days. Beware though, some of these loans have 14-16% ceilings, you have to ask. The fully indexed rate is always listed on the statement, but borrowers are shielded from the full effect of rate increases by the minimum payment, until the loan is recast

Home Equity Lines of Credit HELOC
Since HELOCs are intended by banks to primarily sit in second lien position, they normally are only capped by the maximum interest rate allowed by law in the state wherein they are issued.

Hybrid ARMs

A hybrid adjustable-rate mortgage (ARM) is one where the interest rate on the note is fixed for a period of time, then floats thereafter. The "hybrid" refers to the blend of fixed rate and adjustable rate characteristics found in hybrid ARMs. Hybrid ARMs are referred to by their initial fixed period and adjustment periods, for example 3/1 for an ARM with a 3-year fixed period and subsequent 1-year rate adjustment periods. You will frequently see 3/1, 5/1, 7/1, or 10/1. The date that a hybrid ARM shifts from a fixed-rate payment schedule to an adjusting payment schedule is known as the reset date. After the reset date, a hybrid ARM floats at a margin over a specified index just like any ordinary ARM.

The popularity of hybrid ARMs has significantly increased in recent years. Like other adjustable-rate products, hybrid ARMs transfer some interest rate risk from the lender to the borrower, thus allowing the borrower to offer a lower note rate.

Terminology

Index

All adjustable rate mortgages have an adjusting interest rate tied to an index. Four common indices are:

The index may be applied in one of three ways: directly, on a rate plus margin basis, or based on index movement.

A directly applied index means that the interest rate changes exactly with the index. In other words, the interest rate on the note exactly equals the index. Of the above indices, only the contract rate index is applied directly.

To apply an index on a rate plus margin basis means that the interest rate will equal the underlying index plus a margin. The margin is specified in the note and remains fixed over the life of the loan. For example, a mortgage interest rate may be specified in the note as being LIBOR plus 2%, 2% being the margin and LIBOR being the index.

The final way to apply an index is on a movement basis. In this scheme, the mortgage is originated at an agreed upon rate, then adjusted based on the movement of the index. Unlike direct or index plus margin, the initial rate is not tied to any index; only the adjustments are tied to an index.


12-Month Treasury Average (MTA)

The Monthly Treasury Average (12-Month Treasury Average Index  or 12-MTA) is based on average annual yields on U.S Treasury Securities adjusted to a constant maturity of one year, as made available by the Federal Reserve. The 12-month average is determined by adding together the annual yields for the most recently available 12 months and dividing it by a 12-month average.

Stability: The 12-MTA Advantages. The 12-MTA Index does not move up or down as rapidly as other market interest rates because the 12-MTA is an average of annual yields on U.S. Treasury Securities over a 12-month period. As a result:

* Higher yields are offset by lower yields on a monthly basis throughout the year

* It creates an index that is far less volatile than other pure-rate indices
* Interest rate increases take longer to affect the 12-MTA than other ARM indices

Why the 12-MTA Declines While Other Rates Rise. Even when other rates rise, the 12-MTA Index usually continues to decline for several more months because the 12-MTA is calculated as a 12-month moving average. As a result, it takes a longer period of time for interest rate increases to affect this calculation as lower values throughout the 12-month period keep index increases in check. That means you can enjoy the stability of your 12-MTA, compared to other interest rate indices that generally rise and fall more rapidly. 

The Monthly Treasury Average Mortgage is one of the greatest mortgages for a new home purchase or refinancing mortgages. The 12-MTA allows you the freedom of making mortgage payments of your choice, NEGAM, Interest-Only and the full Index payment base on your rate. For more information on the 12-MTA call today for a free loan comparison to see if the Monthly Treasury Average is right for you.

Cost of Savings Index (COSI)

This index is the weighted average of the rates of interest on the deposit accounts of the federally insured depository institution subsidiaries of Golden West Financial Corporation (GDW). All of the depository institution subsidiaries of Golden West Financial Corporation operate under the name World Savings.

World Savings receives money from consumers in the form of deposits and lends money as home or other loans. The interest rates in effect on these deposits are the basis for the COSI index. It is not based on actual interest paid, but rather the weighted annualized average of all interest rates in effect on World Savings deposit accounts on the last day of each month.

The COSI adjusts monthly and has a one-month reporting lag. It is computed on the last day of each calendar month and is announced on or near the last business day prior to the fifteenth day of the following calendar month.

London Inter Bank Offering Rates (LIBOR)

London Inter Bank Offering Rate (LIBOR) is an average of the interest rate on dollar-denominated deposits, also known as Eurodollars, traded between banks in London. The Eurodollar market is a major component of the International financial market. London is the center of the Euromarket in terms of volume.

The LIBOR is an international index which follows the world economic condition. It allows international investors to match their cost of lending to their cost of funds. The LIBOR compares most closely to the 1-Year CMT index and is more open to quick and wide fluctuations than the COFI rate, as shown on our graph.

There are several different LIBOR rates widely used as ARM indexes: 1-, 3-, 6-Month, and 1-Year LIBOR. The 6-Month LIBOR is the most common.

11th District Cost of Funds Index (COFI)

This index reflects the weighted-average interest rate paid by 11th Federal Home Loan Bank District savings institutions for savings and checking accounts, advances from the FHLB, and other sources of funds. The 11th District represents the savings institutions (savings & loan associations and savings banks) headquartered in Arizona, California and Nevada.

Since the largest part of the Cost Of Funds index is interest paid on savings accounts, this index lags market interest rates in both uptrend and downtrend movements. As a result, ARMs tied to this index rise (and fall) more slowly than rates in general, which is good for you if rates are rising but not good for you if rates are falling.

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