For some, an adjustable rate mortgage is just something that they would never pursue. They’ve heard too many horror stories, and they know far too many people that were just fine until the mortgage adjusted. However, if you dream about the biggest home that you can get into and you really have a stable (and growing!) income, then an adjustable rate mortgage is actually not as evil as people make it out to be. It’s more a matter of being able to truly afford something that’s going to be worthwhile to you in the long run. After all, a home is an investment and if you don’t like where you live, then it takes all of the fun and pleasure out of owning your own home.
Financing your home through an adjustable rate mortgage is tricky, but as the old saying goes — knowledge is definitely power. You want to make sure that you’re always thinking about the road ahead when it comes to your adjustable mortgage, and knowing what indexes are commonly used is going to make that road a lot smoother. Never believe that you just have to go off of what your mortgage broker says. The more information that you can bring to the table when it comes to ARMs, the more well informed your decision is going to be across the board. of course, when you’re dying to own your own home it can be feel like the end of the world if you have to wait, but that’s not the case here. It’s just a matter of looking into the life that you want and going for it full stop.
Back to the topic at hand — what are those common indexes, and why are they important? Well, it goes back to how your adjustable rate mortgage is actually structured. Your payments are based off an index, a margin, the adjustment period, interest rate caps, and even payment caps. There are overall caps that limit how much the interest rate can increase over the life of your loan, but that doesn’t mean that your payments can’t go up significantly. What you’re going to need to focus on here is the index. No, you can’t decide which index your lender will use, but you can ask what index they genera.lly use and shop around for the lender that uses the most stable index. The more volatile the index, the more your payments will fluctuate. This can make planning your house payment very difficult. We still recommend making sure that you use a mortgage calculator to really ensure that you have the maximum amount that your loan could possibly be. With that number you can make sure that you’re not borrowing so much that there might come a point where you can’t make your payments anymore. Even though there are now loan modification programs to help homeowners out, that doesn’t necessarily mean that you’re going to naturally qualify for that type of assistance. This is something that people assumed would be the case for them, only to find themselves feeling trapped and helpless when the loans reset and they had nowhere else to go except to foreclosure.
The common indexes that you will need to look for are below.
Constant Maturity Treasury (CMT or TCM)
This is an index that tracks the weekly or monthly average yields on U.S Treasury securities that have a constant maturity date. Keep in mind that CMT indexes are truly volatile as they indicate the state of the economy — so if you see a mortgage linked to this index, proceed with caution — and make sure that the margin is very low to make up for how volatile this index can be.
Treasury Bill (T-Bill)
These indexes are linked to the results of actions of U.S Treasury bills, notes, and bonds. It’s not as heavily volatile as the CMT indexes, but it can definitely get a little crazy.
12-Month Treasury Average (MTA or MAT)
The Monthly Treasury Average is pretty new, but a lot of people like it. It’s an annual average, which means that it’s pretty steady. It does move about a little more than some of the other indexes, but you will still see enough stability to make it all worthwhile for you in the long run.
Certificate of Deposit Index (CODI)
This is a stable index that is based off the 12 month average of the monthly average yields on CoD rates — the 3-month variety. As you might remember, certificate of deposits are very stable savings tools that don’t grow much, but there’s no loss of principal, either. A lot of ultra-conservative investors like to have them just to make sure that everything is in proper order.
Wells Fargo Cost of Savings Index (W-COSI)
Wachovia and Wells Fargo merged together, so the index had to do the same. Wachovia Cost of Savings Index is no longer in rotation, but the Wells Fargo COSI is still a favorite among some lenders and even mortgage hunters. This is because the index is based on the interest rates that the banking subsidiaries of Wells Fargo & Company pay to people on CDs. Again, CDs are an ultra-stable way of growing your money, albeit slowly. ARMs tied to this index rate tend to leg a bit more when market rates begin to move — which is good when things spiral out of control, but can be bad when you’re seeking relief.
London Inter Bank Offering Rates (LIBOR)
If there’s one index that everyone seems to have heard about, it’s definitely the LIBOR — the London Inter Bank offering Rate. It’s an average of the interest rate on dollar-based deposits. These are known as Eurodollars, and they’re traded between banks in London. This is a major part of the international finance community, so you need to make sure that you keep this in mind before you plunge into a mortgage pinned against this index.
There are some different rates to choose from — 1, 3, 6-Month LIBOR as well as 1-Year LIBOR. A lot of mortgages will follow the 6-Month LIBOR for organization’s sake.
Bank Prime Loan (Prime Rate)
We finally get to the Prime Rate — which is something that people have heard about as well. It’s simply the interest rate charged by banks for short-term loans to their best customers. These are the customers that have great credit and pose little to no risk to the lender in terms of default. Most customers of a bank will not be charged the Prime Rate — they will be charged the Prime Rate + some percentage points. If you have a banking representative that truly wants your business, they can help you get the Prime Rate once your credit score reaches a certain level. It just depends on where your credit is currently in order to figure out where you need to go next. Remember that raising your credit score is something that you will need to do over time!
In terms of mortgages, the Prime Rate is something that rises up quickly but falls slowly. This can be good for some people and bad for others. Again, you will need to make sure that you’re always calculating out how every loan situation will affect you not only in the short term, but the long term as well.
So, which one is right for you? That’s something that you’ll need to use a calculator for. An index that seems higher than another index might also come with a better margin, which could mean a smaller loan payment in the long run. Beware of discounted rates and buydowns that sellers sometimes offer in order to get you into a place that seems out of your reach. The total price of the home can be inflated in order to still recoup the cost lost on providing you with a lower interest rate.
As always, asking as many questions as you possible can really helps when it’s time to start thinking about a home — why not get started today?