What is an Adjustable Rate Loan program
A Adjustable Rate Loan Program (ARM) is an adjustable rate mortgage with a lower initial monthly payment than a fixed rate loan program.
While these loans recieved a bad name during the mortgage melt down, it was not the standard 3/1, 5/1 or 7/1 ARM programs that caused the mortgage market crises. The Pay Option Arms which allowed a client to make payments that were less than the accrued interest on the loan.... Causing negative amortization, were the bad boys. Fortunately, they no longer exist.
The advantages of the ARM's that were left on the market available to consumers are:
- Lower introductory start-rate allows you to make low initial mortgage payments.
- Depending on which ARM you choose, the first three, five, or seven years are locked in at the start rate.
- Your payments are re-calculated at each change date, based upon the new principal balance and remaining term of the loan.
- The ARM could save you thousands of dollars over a fixed rate program if you stay in your home for 7 years or less.
How they work:
Your monthly payment is calculated using the initial start rate, over a 30 year period. At the end of your initial fixed rate period, your monthly payment will change based upon the current program index, margin and caps.
The Below graph is based upon a Conventional 5/1 ARM, Term 30 years. Annual caps of 2% with lifetime cap of 5%, start rate of 3.75% based upon a loan amount of $347,500.00.
| Payment for 5/1 ARM 2/5/2 Caps |
| Year 1-5 @ 3.75% |
$1609.37 |
X 60 = $96540.00 |
| Year 6 @ 5.75% |
$1969.22 |
X 12 = $23,630.60 |
| Year 7 @ 7.75% |
$2404.00 |
X 12 = $28,855.88 |
| Total Payments for ARM |
|
$149,025.00 |
| 30 yr fixed payment @ 5% |
$1865.45 |
X 84 = $156,660.00 |
| Total Savings over 7 Years |
ARM VS Fixed |
$7635.00 |
In year six, the payment will then be calculated using the index rate plus the margin rate, Fully indexed rate. If the fully indexed rate should exceed the maximum annual cap (2%) then your cap kicks in and the maximum you interest rate can change is 2%. Your loan is then re-amortized over the remaining term of the loan. On a thirty-year loan, the remaining term is twenty-five years.
The note rate is the interest rate the bank will charge you each month. Some programs will use the introductory rate as the note rate for the first initial fixed period. After that introductory period, the note rate will then adjust to the index rate plus the margin rate, with the annual caps as the consumer's protection.
| EXAMPLE: |
1 Year Treasury Index |
2.875 |
|
Margin |
2.250 |
| Fully Indexed Rate |
Index + Margin |
5.125 |
| Payment Calculation: |
| Year 1-5 |
use Introductory Rate |
4.00% |
|
Term |
30 years |
|
Initial Loan Amount of $347,500.00 |
|
| Year 6 |
Index + Margin |
5.125 |
|
Term |
25 years |
|
on Remaining Principal Balance |
ARM loan programs are right for you if you'd like to own your property only for a short time, and prefer affordability in your monthly payment.
Index plus Margin
The index is the base rate used to determine your interest rate. Most people are familiar with the Prime rate, T-bill or Cofi. Government and FNMA ARM programs are is usually based on one of the following indexes:
- 1 Year Treasury
- London InterBank Offered Rate (LIBOR)
The Margin is the number of percentage points (for example, 2.25) the lender adds to the index rate to calculate the Fully Indexed Rate, or note rate, at each adjustment. The margin is fixed at the time the loan is funded.
Compare advantages of other Loan Programs
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