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  • Adjustable-Rate

  • What Is An Adjustable Rate Mortgages

    Simply put, an adjustable rate mortgage is one where your monthly mortgage payment can change over the length of the loan term, known as amortization terms.

    The loan may have a total term of 30-years, but along that timeframe, the payment amount can vary - hence "adjustable".

    These loans can be great options for the right person, and can also be the wrong options.  Let's dig a bit deeper on adjustable loans, the loan terminology you need to understand, and how they can adjust.

    The advantage is lower rates now. The disadvantage is uncertainty.

    Since the rates are lower adjustable rate loans are easier to qualify for. Often, for the first time buyer, they are the only alternative.

    There are several parameters regarding variable rate loans:

    • The first is the Index (these are described extensively below.) The Index is related to the cost to the lender. Different lender's have different costs of funds and thus use different indices.
    • The start rate is he initial interest rate. It may last for 3 months, 6 months, 1 year, or as long as 7 years. The longer the initial period the higher the rate.
    • The margin is what is added to the value of the Index at the time of adjustment. The result is generally rounded to the nearest 0.125%.
    • The term cap describes how much the rate can go up or down when it adjusts. This is more important for volatile indices. Generally, the limit is 1% every 6 months (if the loan adjusts every 6 months) or 2% a year if it adjusts once a year.
    • The life cap or ceiling is the highest interest rate that the loan can have during its entire life.
    • Some loans have negative amortization features (not common). A "negative amortization" loan may start at 5% and have an initial payment of $1,000. Even though the interest rate might adjust after 3 months you may be able to keep the start payment for an entire year. Your loan balance will go up if you choose to make the minimal payment. The minimal payment will go up by 7.5% from year to year. Depending on the loan program the "negative amortization" feature will cease when your loan balance reaches between 110% to 120% of the original loan amount. The "negative amortization" does not extend the life of the loan.

    Definition of Common Adjustable Rate Indices

    SOFR - PROPER NAME: Secure Overnight Financing Rate. - In late 2020, for a wide variety of reasons, the SOFR index has become the popular index for long-term home mortgage loans. This index is published by the Federal Reserve Bank of New York.

    1 Year T-Bill 

    PROPER NAME: Yield on Treasury Security Adjusted to a Constant Maturity of One Year
    The One-Year Treasury Security index (or "T-Sec") is associated with ARMs that feature annual rate adjustments. It is calculated by the

    Federal Reserve Board and has both a weekly and monthly value; most lenders use the weekly value. This index reflects the state of the economy, and responds quickly to economic changes.
    Confusion can arise when some lenders use the term "one year Treasury bill." Most one-year ARMs -- but not all -- are tied to the Constant Maturity of the One Year Treasury Security.

    If you have a loan you are interested in refinancing you can generally find the details (Index, Margin and life cap) by looking in paragraph #4 of the "Adjustable Rate Note" or "Adjustable Rate Rider". This will be with the papers you received from the escrow company.

    LIBOR

    Stands for London Interbank Offered Rate. It is a measure of commercial lending rates of a group of London banks. It is similar to Prime. It moved up and down rapidly. It can best be obtained daily from the Wall Street Journal.
    6 Mos. CD
    This is a measure of what banks are paying on 6 month certificates of deposit. It moves less rapidly than LIBOR or T-bill but more rapidly than COFI.

    COFI or 11th District Cost of Funds. (not very common)

    PROPER NAME: Monthly Weighted Average Cost of Funds for 11th District SAIF-Insured Institutions.
    This index, used primarily for ARMs with monthly interest rate adjustments, is calculated by the Federal Home Loan Bank of San Francisco. The 11th District represents the SAIF-insured savings institutions (savings & loan associations and savings banks) in Arizona, California and Nevada.

    The cost of funds reflects the interest rates paid by institutions for savings accounts, FHLB advances, money borrowed from commercial banks, and other sources.

    Since the largest part of a cost of funds index is interest paid on savings accounts, this index lags behind the economy. As a result, ARMs tied to this index rise (and fall) more slowly than rates in general. However, such ARMs often have payment caps, but no month-to-month interest rate caps.

    Getting your home loan with Cambria Mortgage? You can call us at (651) 552-3681 to find out the current index.  Otherwise, the current index for adjustable loans is readily available from multiple sources online.

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