ARM about to Adjust? Get the Facts First.

If you are one of many Americans who took out an ARM loan a few years ago, you would think from reading many reports that your rate will skyrocket come the first adjustment period. I suggest you do some research on your Adjustable Rate Mortgage terms before sounding the panic alarm.  The first things you will want to find out are:  your Index, your Margin, and your Caps.

Index: The index in which you have an adjustable rate mortgage plays a large part in how your rate can adjust, as the yield or interest rate is added to the margin to determine your new rate, subject to any Caps in place.  Many mortgages have an index based on the 1 Year Treasury Bill, LIBOR(London Interbank Daily Offered Rate), or the COFI(Cost of Funds Index).  The MTA is the Monthly Treasury Average over a given timeframe.

Here are the yields of many Market Indices as of 7/7/2009:
Prime:   3.250%
1 Yr Libor 1.511%
1 Yr T-Bill 0.490%
1 Mth COFI 4.244%
1 Mth MTA  4.788%
6 Mth LIBOR 1.023%
1 Mth LIBOR 0.302%

Margin: The margin is a percentage that is added to your Index to determine your fully indexed rate.  Many Prime ARM loans have margins ranging from 2.25% to 3.5%.  Unfortunately, there are Subprime ARM loans with margins ranging from 4.25% to 9.25% or more.  The ARM loans with high margins are the “toxic” ARM loans you read and hear about in the news all the time, because the loans adjust upward to the maximum of the caps each adjustment.

Caps: Caps refer to the maximum amount your new rate can adjust in a given period.  Usually there is a First Adjustment Cap, a Subsequent Adjustment Period Cap, and a Lifetime Rate Cap.  Caps of 2/2/6 would mean a rate could adjust as much as 2% in the first adjustment (regardless of the fully indexed rate), 2% any adjustment thereafter (regardless of the fully indexed rate), and 6% over the life of a loan (regardless of the fully indexed rate).  Some loans may have a “floor” for adjustments as well, meaning that your rate may not decrease a certain amount from the initial rate.

Calculating an adjustment: the possible good news.  If you have a 5/1 ARM based on the 1 year Treasury Bill(.49%) with a margin of 2.75% and 2/2/5 Caps, well, you are in good shape for now.  .49%(Index) + 2.75%(Margin) = 3.24% Fully Indexed.(You may have a floor in your adjustment).  Do yourself a favor and check out your mortgage note you signed, or contact your loan servicer for your ARM details. 

Keep in mind, if you have sufficient equity, that now is still a great time to refinance into a fxed rate or Prime ARM loan depending on your needs.