Adjustable Rate Mortgages – Determining Rates

Adjustable rate mortgages (ARMs) can be highly attractive to home buyers due to their initially low interest rates. However, understanding whether an ARM is a good deal involves knowing how its rate index works.

Indexes are used to set the interest rates for ARMs. They reflect general interest rates across various financial markets. Common indexes include:

1. Certificate Deposits (CDs): Fixed-time period investments offered by banks, with guaranteed returns. The rate of CDs can be used to determine ARM interest rates.

2. Treasury Bills (T-Bills): Short-term government securities. The interest rate on T-Bills is used by lenders to set ARM rates.

3. Cost of Funds Index: Represents the average rates used by banks in certain regions, such as Nevada, Arizona, and California.

4. LIBOR (London Interbank Offered Rate): An index based on the interest rates international banks charge to borrow U.S. dollars on the London markets. LIBOR rates can fluctuate quickly, affecting ARM rates.

The importance of these indexes lies in their role in setting the base interest rate for your ARM. For example, if your ARM is based on the LIBOR index, and the LIBOR rate is 2.2 percent at the start, this is your initial interest rate. However, if the LIBOR rate increases, your ARM rate will increase accordingly.

The actual interest rate you pay includes the bank’s margin added on top of the index rate, usually ranging from 2 to 3 percent. Therefore, it’s essential to carefully review y