Worrying about what kind of mortgage you want to take is difficult enough, without having to decide on which interest rate index is going to be the deciding factor on what your interest rates on your Adjustable Rate mortgage will be!
When we speak of the “index”, we are speaking of the base financial instrument that the adjusting rates will be based on. Indices can include the CD rate, the Treasury Bill rate, the Fed Funds rate, the LIBOR rate and, the new kid on the block, the options ARM.
You must initially understand that an ARM is a mortgage with an interest rate that moves up or down within a certain set period, and the movements are predicated upon the movements of the underlying index. One such instrument would be Certificates of Deposit-your loan rate would fluctuate up and down with the CD rate. Adjustable rate mortgages have adjustment caps, which says that the interest rate can only be adjusted at given periods, even if the underlying interest rate goes up more frequently; this can be an advantage if you just readjusted and then rates move up. Of course, the reverse can happen, and if your rate has recently been readjusted at a high rate, and then the index moves down, you will not be able to take advantage of that until your next readjustment period.
Your ARM may be tied to the Treasury Bill rate, which is the rate the United States Government pays on its 90 day investments. Another index that is often used is the Federal Funds Rate. Another popular index used by many is the LIBOR, or the London Interbank Offered Rate, which well rated international companies pay to borrow.
The index is a personal choice, based on the individual mortgage, and how the borrower feels interest rates will behave. CD ARMs change every six months, for example, and therefore react more readily to interest rate changes. On the other hand, if your ARM is based on T Bills, it will move more slowly. LIBOR is one of the quickest moving indices, so if you want to take advantage of quickly falling interest rates, this is the one to use.
As we mentioned, new products are introduced each day, and one of the newest it the option ARM, which allows the borrower to choose how much he wants to pay on his home loan each month. There is a minimum payment that covers the interest (so the bank gets its money) and then the other options will pay off some portion of equity. One of the big problems with an option mortgage is that you can get an increasing instead of decreasing mortgage; this is also called as negative amortization.
With this dizzying choice in interest rate scenarios for your mortgage, the best idea is to meet with a mortgage consultant who can explain all of them to you and advise you best on your needs.
