Mortgages Made Simple with Rick Gundzik

Tuesday, May 24, 2005
ARMs Index + Margin = ???
Most of you know an ARM is an adjustble rate mortgage, but very few loan officers explain how an ARM interest rate is calculated.

An ARM has 5 key numbers; the start rate, the annual cap, the lifetime cap, the index and the margin. The start rate is the interest rate that the loan starts at, eg. a 1 year ARM starts at 4.75% and stays at 4.75% for 1 year. The annual cap is the maximum that the loan can increase in one year. The most common annual cap is 2%. So after 1 year the loan in our example can not go over 6.75%. The lifetime cap is the maximum the loan can increase ever. Typically 6%, so our example loan can never go over 10.75%.

Now it gets tricky. The index plus margin is the rate your loan goes to after 1 year. Let's say the index is currently at 3.5%, if your margin is 2.75%, your new rate is 6.25%. Seems simple in our example, but generally this isn't explained very well.

That brings us to what a margin and index actually are: The margin is a seemingly arbitrary number that lenders calculate to build their cost into the loan. Margins range from 2% to 4% on normal loans to as high as 7-8% on subprime loans.

An index can be one of the following:
LIBOR - London Interbank Offered Rate
COFI - Cost of funds index
1 Year Treasury - The 1 year treasury bill yield

There are other indexes, but these are the most common. In general, the LIBOR and COFI are less volatile then the Treasury index, which means your interest rate won't go up as quickly.

The main point to take away from this, is be certain you can afford to pay the margin plus the index because this is the rate your loan will be at in a relatively short time.

The next blog will discuss fixed period ARMs.

For questions, please contact us at
posted by Pac Res @ 10:28 PM  
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