ARM loans, or Adjustable Rate Mortgages almost all have a feature which can greatly affect how much your monthly mortgage payment or mortgage rate may increase after the introductory fixed rate period of your loan expires, called the Index.

An ARM’s Index is really just a guide that allows different lenders to measure and compare changes in interest rates to determine the basic cost of the money they are lending you.

A major increase in the value of an index from the time you purchased the home or last refinanced can cause a significant increase in your mortgage payment, because the ARM’s index can be considered an underlying rate which affects, along with the margin, the final note rate which you are charged when your ARM loan begins adjusting at the en of its fixed introductory period. It just so happens that the major indices used to calculate the rates of ARM loans are currently at 3 year highs, which means that borrowers who are in very low rate adjustable ARMs are at the highest risk of experiencing a huge increase in the mortgage payments on their adjustable rate ARM loans.

Many of these borrowers are seeking to refinance their ARM loans to secure fixed rate mortgages, and solid options are available still available in this arena, however these options are becoming fewer and further between each day as the standards of the lending industry tighten in response to higher interest rates anticipated on the horizon. It may be advisable for homeowners in ARM loans to evaluate their risks and the options they may have to refinance and convert their adjustable rate mortgage to a fixed rate today, before their rates adjust over the next few years, and before credit standards remove the option of easily refinancing.

Lenders and investors in Adjustable Rate Mortgages utilize a variety of indexes for ARM mortgages, including the performance, return or yield of 1 month, 1 year, 3 year, 5 year and even 10 year US Treasury securities (10 year note yield indices are rarely used in adjustable rate ARM loans and are more commonly used to set the rate of 30 year fixed rate mortgages)

Popular ARM Indexes commonly used as adjustable rate mortgage benchmarks include:
>> Prime Rate (Bank Prime Loan)
>> MTA or MAT (12-Month Treasury Average)
>> CMT or TCM (Constant Maturity Treasury)
>> COFI (11th District Cost of Funds Index)
>> LIBOR (London Inter Bank Offering Rates)
>> T-Bill (Treasury Bill)
>> COSI (Cost of Savings Index)
>> CODI (Certificate of Deposit Index)
>> CD (Certificates of Deposit Indices)

Other indexes which may occasionally be used in Adjustable Rate ARM mortgages are highly varied, however homeowners may have an ARM mortgage with an index from the following list (although more rarely than those ARM indexes mentioned above):

>> Cost of Funds component indices:
- Federal Cost of Funds Index
- Semi-annual National Average Cost of Funds Index
- Quarterly Average Cost of Funds
- National Monthly Median Cost of Funds Index

- OR -

- RNY (Fannie Mae or Freddie Mac Required Net Yield)
- Semiannual Weighted Average Cost of Funds Index
- National Average Contract Mortgage Rate

The prime rate is an interest rate which banks charge their highest credit customers for short term loans. It is called prime because the high credit profile of a “prime” borrower presents very little risk to the lender, bank or investor. While the prime rate is not centrally set by the government, banks do tend to set the prime rates at equal levels between themselves and they do not change the prime rate often. However, the Wall Street Journal does publish a prime rate which averages the current prime rates of 75% of the largest 30 banks in the country.

As an ARM index, the Wall Street Journal’s prime rate index serves primarily as the base rate or index for the broad class of home equity loan and home equity line of credit second mortgage products, so you may have a mortgage tied to the prime rate and not even know it. Prime rate index adjustable rate mortgages are generally relatively expensive by comparison to fixed rate mortgages, and many borrowers will seek to refinance a prime rate indexed home equity loan or HELOC (Home Equity Line of Credit) to convert to a fixed rate prior to the end of the adjustable rate mortgages introductory period, because rates and payments may jump dramatically upon these loans’ initial adjustment.

The MAT 12 month Moving Average Treasury Index, commonly referred to as the MTA, is a very popular new ARM index based on the 12 month average of the monthly mean yields of United States Treasury securities, which are adjusted further to a constant maturity of one year. More simply put, the MTA is calculated by averaging the previous 12 monthly values of the 1 year CMT, which means that it is actually more stable than the more traditional 1 Year CMT index. The MTA or MAT index is very closely tracked to two other popular ARM indices, the CODI and the COFI (11th District), and has experienced an explosion in popularity due to its serving as the basis for the majority of Pay Option ARM cash flow adjustable rate mortgages. Like the COFI and CODI indexes, the MTA in 2007 to 2008 is at a 3 to 4 year high, meaning that borrowers with MTA or MAT index ARM loans may find it advantageous to convert their ARM loan to a fixed rate.

While it was previously impossible to obtain a fixed rate home loan which offered the minimum payment flexibility of Pay Option ARM type mortgage, we now offer a mortgage which is fixed for 30 years with payment options as low as 1.95%. This 30 Year Fixed Rate Cash Flow mortgage is our most popular refinance loan because it preserves the flexibility of the Option ARM while adding the security of a 30 year fixed rate, and is available to borrowers who need to borrow up to 80% of the value of their home or less.

One of the more volatile families of indexes which are used in ARM adjustable rate mortgages, CMT indexes are closely linked to the current economic climate in the United States. CMT Indexes measure the monthly or even weekly average yields of United States Treasury securities adjusted to a constant maturity. Also known as Treasury Yield Curve Rates, Constant Maturity Treasuries are not real securities, but are derived from the market yields of actual real treasury securities like 1 3 and 6 month bills, 2, 3, 5, 10 year and 30 year notes, and other off the run securities with maturities ranging from 7 to 20 years, and are reported by the Federal Reserve Board. While we mentioned that CMT Indexes are volatile, they are actually more stable than the CD Index, but less stable than the MTA or COFI indexes for comparison’s sake.

The most widely used CMT index is the 1-year CMT, which is used on ARM mortgages whose rates adjust annually once their initial fixed period ends. Other names for this index include the 1 Year T-Bill Index, the 1 Year Treasury Spot Index, and the 1 Year Treasury Security Index.

Other variants of the CMT index which are less popular but are still used in certain adjustable rate mortgages are the 3 Year CMT and the 5 Year CMT.

Due to its high degree of volatility, and its popularity as an ARM index, borrowers with CMT index adjustable rate mortgages may wish to explore their options to refinance due to current economic outlooks over the next 2 years, or risk significant payment shock when their ARM mortgage rates adjust at the end of the fixed period.

One of the most stable indexes along with the MTA is the 11th District COFI, so named because it measures the weighted average of interest rates paid by the 11th District of the Federal Home Loan Bank District headquartered in California, Arizona and Nevada. It is stable because banks pay interest mostly on savings accounts, and we don’t have to tell you how slowly they change the interest rates!

11th District COFI Index Adjustable Rate ARMs are very popular in ARM mortgages whose rates adjust every month, and a large percentage of minimum payment option ARM mortgages use this index. While traditionally slow to react to volatility I the market, the COFI index is at a 4 year high and a side effect of its stability is that it is much slower to react to lower market interest rates. That means if you are in a COFI index ARM mortgage which is in its fixed period, you could be in for a shock when your fixed period ends and the ARM makes its initial adjustment, because the rates are much higher today than when you took your mortgage out, and also because any downward trends in rates do not reflect as quickly, locking you into this higher payment much longer. A COFI indexed ARM may make sense if you have a long fixed period, but the ability for the loan to adjust monthly may not be desirable to some borrowers after the fixed period is over. Many borrowers in COFI index ARM mortgages are seeking to refinance before their rate becomes adjustable, however have found that fixed rate mortgages often lack the payment options available in their COFI Index ARM. The solution may be to refinance into a new 30 year fixed mortgage with a minimum payment option capability or to seek a COFI or MTA option ARM with a long initial fixed period of 3 or 5 years.

The LIBOR Index is one of the few truly international indexes used by American adjustable rate mortgage lenders. The LIBOR London Inter Bank Offering Rate takes the average of the interest rate on Eurodollars (which are dollar denominated deposits) which are exchanged between London banks, which are the center of the huge international Eurodollar market (Euromarket). Unlike the CMT and other indexes which follow the American economy very closely, the LIBOR index is closely linked to the economic conditions of the entire global economy. It is very similar and closely linked to the Constant Maturity Treasury (CMT) Index, and is used as an Adjustable Rate ARM index in its 1 month, 3 month, 6 month LIBOR and 1 Year LIBOR varieties for loans which adjust at those intervals (so an adjustable rate mortgage which adjusts every six months would use the 6 month LIBOR, etc)

Many of the most aggressively priced introductory start rate ARM mortgages offer the LIBOR index, and LIBOR indexes are even being used in Cash Flow Option ARM mortgages (even though LIBOR loans did not traditionally offer negative amortization features). As an ARM Index, lenders will generally use the WSJ LIBOR (as quoted in the Wall Street Journal) or Fannie Mae’s posted LIBOR rate, which you may find by reviewing your loan documents.

LIBOR Indexes are at a 6 year high, so borrowers whose LIBOR Index adjustable rate mortgages are approaching the end of their fixed rate period may feel it prudent to consider their options to fix their interest rate prior to the initial adjustment.

Not to be confused with the 1 Year T-Bill Index (which is actually a Constant Maturity Treasury Index) , the T-Bill Indexes, particularly the 6 month Treasury Bill Index, are calculated weekly by measuring the results of US Government auctions of 4 week, 13 week and 26 week Treasury Bills (which are also called 1 month / 28 day, 3 month / 91 day, or 6 month / 182 day T-bills)

The most commonly used T-Bill Index for ARM mortgages is the Weekly 6 Month T-Bill (Auction High) Mortgage ARM Index, which is the discount rate for the 26 week Treasury Bill bought at the most recent US Government Treasury Bill auction the previous week. The 6 month T-Bill Index is used as an ARM index mostly in adjustable rate mortgages whose rates adjust every six months.

Like the CMT Indexes, the T-Bill Index moves very rapidly with market volatility, and can be a risky proposition in markets with rising rates such as today’s market. Borrowers with T-Bill Index ARM loans are increasingly seeking the safe harbor of fixed rate mortgages, which are available at rates very comparable to the rates on T-Bill Index ARM loans.

CD Indexes (Certificate of Deposit)
While the 12 month moving average of the 3 month CD is arguably more widely used today (this is called the CODI), the CD indexes as a group are calculated by averaging the interest rates on the Certificates of Deposit traded on the secondary marketing the USA. While there are 1 month, 3 month, 6 month CD and 1 year CD Index ARM Indexes, the 3 month and 6 month Indexes are the ones which are used by lenders the most as an index for setting the floor rate of an adjustable rate mortgage. The 6 month CD Index changes very rapidly compared to the CODI, because the 6 month CD Index is calculated monthly whereas the CODI Index averages the 3 month CD over a year.

To make a long story short, volatile ARM indexes such as the 6 month CD present borrowers with a lot of risk when rates are rising as they are currently, however can be good in a market where rates are falling quickly. If you are in a CD Index loan, 6 month CD Index or otherwise, refinancing into a fixed rate or into an ARM with a slower moving index is definitely something to consider.

CODI Certificate of Deposit Index
Like its closely linked counterpart, the MTA index, the Certificate of Deposit Index is a slow moving annual index which is much more stable than the CD Index or the Constant Maturity Treasury Index. The CODI is calculated by taking a 12 month average of the monthly yields on 3 month Certificate of Deposit rates, which are published nationally.

CODI Index ARM mortgages are similar in look in feel to MTA or MAT index ARM loans, and many feature payment options which borrowers who are seeking to refinance into a fixed rate feel they must give up when the convert. This is not necessarily the case anymore, as there are new mortgages available with up to 30 year fixed rate periods which offer cash flow minimum payment option choices just like a CODI Option ARM.

National Average Contract Mortgage Rate
The National Average Contract Mortgage Rate is notable because many lenders still use this interest rate when they “reset” the interest rate on an Adjustable Rate Mortgage or ARM loan, and was once the only federally sanctioned adjustable rate mortgage index. While it has for the most part fallen out of favor, it is still in use and therefore notable. Also called the National Mortgage Contract Interest Rate, it closely tracks the Fannie Mae 30/60 RNY and is reported by the Federal Housing Finance Board each month after its Monthly Interest Rate Survey.

RNY Fannie Mae & Freddie Mac Required Net Yield
Used very often in the conversion of ARM mortgages to fixed rate mortgages, the Fannie Mae RNY Required Net Yield is not an ARM index per se, but a calculation of the minimum yield that Fannie Mae requires for a given loan delivered to them within a given timeframe. If that sounds complicated, it is, but the simple explanation is that you may be exposed to this index if you are in a convertible ARM or balloon/reset mortgage.

The most commonly used index is the 30/60, which is the minimum yield accepted by Fannie Mae for 30 year fixed rate mortgages delivered for sale to Fannie Mae within 60 days by lenders.

If you are in a convertible ARM or balloon/reset mortgage, you may have significantly better options to convert to a fixed rate than your current loan affords, especially if you are looking to increase your monthly cash flow or wish to defer interest.

The Pay Option ARM mortgage has become one of the most popular home loans in the USA, and is definitely the fastest growing option in high cost states like California, Florida, New York, New Jersey and Connecticut. While many people love the start rates which can be as low as 0.25%, there are a lot of people who don’t feel comfortable with the possibility of their payments increasing in as little as 1 month on many of the most common programs. The common wisdom is that Option ARMs are incredible products for savvy homeowners and investors, but may be too powerful for the average homeowner to handle. With all of the turbulence in interest rates and the mortgage sector in general this year, Adjustable rate mortgages may be too risky an option for most borrowers, and many are looking for ways to lower their payments and at the same time fix their rate to weather the storm. Since Fixed Rates usually mean higher payments, many homeowners are left wondering what the best thing is to do. Read the rest of this entry »