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Unformatted text preview: mal or “fully indexed” ARM rate. HIGHER FUTURE PAYMENTS
Against these advantages, there is the risk that an increase in interest rates will lead to higher monthly payments in the future. It's a trade–off–a lower initial rate in exchange for assuming more risk. Here are some questions the borrower needs to consider: Is my income likely to rise enough to cover higher mortgage payments if interest rates go up? Will I be taking on other sizable debts, such as a loan for a car or tuition, in the near future? How long do I plan to own this home? (If one plans to sell soon, rising interest rates may not pose the problem they do if one plans to own the house for a long time.) Can my payments increase even if interest rates generally do not increase? HOW DOES AN ARM WORK?
The basic features of any ARM are the adjustment period (frequency of adjustment), the index on which the adjustments are based, and the margin charged by the lender. At the end of each adjustment period, the ARM interest rate for the ensuing period is determined by the formula: Dynasty School (www.dynastySchool.com) 9-9 REAL ESTATE FINANCE ARM Interest Rate = Index Rate + Margin CHARACTERISTICS OF ARM LOANS INDEX
Once the initial interest rate is established, the rate is tied to some neutral index, which is one that is beyond the control of the lender or the borrower. A government index, such as the “cost of funds index” of the 11th District of the Federal Home loan Bank of San Francisco, is an example. Some ARMs are tied to certain U.S. Treasury notes. Others are tied to international indexes, such as the London Interbank Offered Rate (LIBOR). The borrower should know what index will be used, how often it changes, how it has behaved in the past, and where it is published. MARGIN
To determine the interest rate on an ARM, lenders add to the index rate a few percentage points called the “margin.” The amount of the margin can differ from one lender to another, but it is usually constant over the life of the loan. In comparing ARMs, both the index and...
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- Spring '10