Standard ARMS and the Differences
6-Month Certificate of Deposit (CD) ARM
Fixed Rate Mortgages
The most common type of mortgage program where your monthly payments for interest
and principal never change. Property taxes and homeowners insurance may increase,
but generally your monthly payments will be very stable.
Fixed rate mortgages are available for 30 years, 20 years, 15 years and even
10 years. There are also "biweekly" mortgages, which shorten the
loan by calling for half the monthly payment every two weeks. (Since there
are 52 weeks in a year, you make 26 payments, or 13 "months" worth,
every year.)
Fixed rate fully amortizing loans have two distinct features. First, the interest
rate remains fixed for the life of the loan. Secondly, the payments remain
level for the life of the loan and are structured to repay the loan at the
end of the loan term. The most common fixed rate loans are 15 year and 30
year mortgages.
During the early amortization period, a large percentage of the monthly payment
is used for paying the interest. As the loan is paid down, more of the monthly
payment is applied to principal. A typical 30 year fixed rate mortgage takes
22.5 years of level payments to pay half of the original loan amount.
Standard ARMS and the Differences
A few options are available to fit your individual needs and your risk tolerance
with the various market instruments.
ARMs with different indexes are available for both purchases and refinances.
Choosing an ARM with an index that reacts quickly lets you take full advantage
of falling interest rates. An index that lags behind the market lets you take
advantage of lower rates after market rates have started to adjust upward.
The interest rate and monthly payment can change based on adjustments to the
index rate. GoToTop
6-Month Certificate of Deposit (CD) ARM
This program has a maximum interest rate adjustment of 1% every six months.
The 6-month Certificate of Deposit (CD) index is generally considered to react
quickly to changes in the market.
1-Year Treasury Spot ARM
This program has a maximum interest rate adjustment of 2% every 12 months.
The 1-Year Treasury Spot index generally reacts more slowly than the CD index,
but more quickly than the Treasury Average index.
6-Month Treasury Average ARM
This program has a maximum interest rate adjustment of 1% every six months.
The Treasury Average index generally reacts more slowly in fluctuating markets
so adjustments in the ARM interest rate will lag behind some other market
indicators.
12-Month Treasury Average ARM
This program has a maximum interest rate adjustment of 2% every 12 months.
The Treasury Average Index generally reacts more slowly in fluctuating markets
so adjustments in the ARM interest rate will lag behind some other market
indicators.
Cost of Funds Index (COFI)
The 11th District Cost of Funds is more prevalent in the West and the 1-Year
Treasury Security is more prevalent in the East. Buyers prefer the slowly
moving 11th District Cost of Funds and investors prefer the 1-Year Treasury
Security.
The monthly weighted average 11th District has been published by the Federal
Home Loan Bank of San Francisco since August 1981. Currently more than one
half of the savings institutions loans made in California are tied to the
11th District Cost of Funds (COFI) index.
The Federal Home Loan Bank's 11th District is comprised of saving institutions
in Arizona, California and Nevada.
Few people who use and follow the 11th District Cost of Funds understand exactly
how it is calculated, what it represents, how it moves and what factors affect
it.
The predecessor to the 11th District Cost of Funds index was the District
semiannual weighted average cost of funds published for a six month period
ending in June and December. The San Francisco Bank was the first Federal
Home Loan Bank to publish a monthly cost of funds index.
The funds used as a basis for the calculation of the 11th District Cost of
Funds index are the liabilities at the District savings institutions: money
on deposit at the institutions, money borrowed from a Federal Home Loan Bank
(known as advances) and all other money borrowed. The interest paid on these
types of funds is the cost of these funds.
The ratio of the dollar amount paid in interest during the month to the average
dollar amount of the funds for that month constitutes the weighted average
cost of funds ratio for that month.
The average cost of funds is said to be weighted because the 3 kinds of funds
and their costs are added together before a ratio is computed rather than
calculating averages individually for the 3 sources and using a simple average
of the three ratios. This gives the greatest weight to the interest paid on
deposits, and explains the delayed reaction of the index to rising fixed rate
mortgages. GoToTop
Interest Rate Buy Downs
The most common buy down is the 2-1 buy down. In the past, for a buyer to
secure a 2-1 buy down they would pay 3 points above current market points
in order to pay a below market interest rate during the first two years of
the loan. At the end of the two years they would then pay the old market rate
for the remaining term.
As an example, if the current market rate for a conforming fixed rate loan
is 8.5% at a cost of 1.5 points, the buy down gives the borrower a first year
rate of 6.50%, a second year rate of 7.50% and a third through 30th year rate
of 8.50% and the cost would be 4.5 points. Buy downs were usually paid for
by a transferring company because of the high points associated with them.
In today's market, mortgage companies have designed variations of the old
buy downs rather than charge higher points to the buyer in the beginning they
increase the note rate to cover their yields in the later years.
As an example, if the current rate for a conforming fixed rate loan is 8.50%
at a cost of 1.5 points, the buy down would give the buyer a first year rate
of 7.25%, a second year rate of 8.25% and a third through 30th year rate of
9.25%, or a three quarter point higher note rate than the current market and
the cost would remain at 1.5 points.
Another common buy down is the 3-2-1 buy down which works much in the same
ways as the 2-1 buy down, with the exception of the starting interest rate
being 3% below the note rate. Another variation is the flex fixed buy down
program that increase at six month interval rather than annual intervals.
As an example, for a flex fixed jumbo buy down at a cost of 1.5 points, the
first six months rate would be 7.50%, the second six months the rate would
be 8.00%, the next six months rate would be 8.50%, the next six months rate
would be 9.00%, the next six months the rate would be 9.50% and at the 37th
month the rate would reach the note rate of 9.875% and would remain there
for the remainder of the term. A comparable jumbo 30 year fixed at 1.5 points
would be 8.875%. GoToTop
Balloon Mortgages
Balloon loans are short term mortgages that have some features of a fixed
rate mortgage. The loans provide a level payment feature during the term of
the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans
do not fully amortize over the original term. Balloon loans can have many
types of maturities, but most balloons that are first mortgages have a term
of 5 to 7 years.
At the end of the loan term there is still a remaining principal loan balance
and the mortgage company generally requires that the loan be paid in full,
which can be accomplished by refinancing. Many companies have other options
such as a conversion feature at the end of the term. For example, the loan
may convert to a 30 year fixed loan at the thirty year market rate plus 3/8
of a percentage point. Your conversion can be guaranteed based on certain
criteria such as having made your last 24 payments on time. The balloon mortgage
program with the conversion option is often called a 7/23 Convertible or 5/25
Convertible. GoToTop