How to calculate the change in rate in your ARM

February 15, 2007 at 6:25 pm 1 comment

Chances are, if you own a home or are looking at buying one, you are familiar with an ARM. For those that don’t know an ARM is an adjustable rate mortgage. ARM’s are usually recommended by mortgage or lending companies to folks who are having trouble fitting the monthly payment into their budget. With an ARM, the rate starts out lower than standard fixed rates, but, as the name states, the rate adjusts over time. If you have an ARM and are unaware of the standard method to which the rates adjust, this post is for you.

First, if you have an ARM, we recommend you refinance as soon as possible! Your best bet is to stick to a fixed rate where the chances of getting your head taken off by rate increases are nonexistent. You know exactly what the monthly payment will be. If for some reason, you prefer to remain in an ARM. Here’s how you can plan for the inevitable rate increases:

  1. Your ARM adjustments are based on the movement of an index. Grab your original note and find your index. The most commonly used index is the Treasury Bill (T-Bill). The 1-year ARM uses a T-Bill, and the 3-year ARM uses the 3-year T-Bill, and so on. Other commonly used indexes are LIBOR and The 11th District Cost of Funds.
  2. Find out what margin was assigned to your loan.
  3. Your ARM moves as the index moves. The index is published daily in the Wall Street Journal (WSJ).

Example: If you have a 1-year ARM that adjusts with the 1-year T-Bill and a margin of 2.59, at the 1 year anniversary of your closing, you would look up the 1-year T-Bill in the WSJ. Add the T-Bill to your margin and you have your new rate (if it’s not capped).

4.41 (T-Bill) plus 2.59 (margin) = 7% (new interest rate)

Nearly all ARM’s start below margin the first year, guaranteeing a payment increase at the anniversary, unless rates drop.

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Entry filed under: Real Estate and Mortgages.

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