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Fixed Rate Mortgages
Adjusted Rate Mortgages
(ARM)
Standard
ARMS and the Differences
Introductory Rate ARM's
London Inter Bank
Offered Rate (LIBOR)
Balloon Mortgages
Interest Rate Buydowns
Cost
of Funds Index (COFI)
Graduated
Payment Method (GPM)
Choosing The Best Program |
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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 "bi-weekly" 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. |
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Adjusted Rate
Mortgages (ARM)
These loans generally
begin with an interest
rate that is 2-3 percent
below a comparable
fixed rate mortgage,
and could allow you
to buy a more expensive
home.
However, the interest
rate changes at specified
intervals (for example,
every year) depending
on changing market
conditions; if interest
rates go up, your monthly mortgage payment
will go up, too. However,
if rates go down, your mortgage payment
will drop also.
There are also mortgages that
combine aspects of
fixed and adjustable
rate mortgages -
starting at a low fixed-rate
for seven to ten years,
for example, then adjusting
to market conditions.
Ask your mortgage professional
about these and other
special kinds of mortgages that
fit your specific financial
situation |
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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.
6-Month Certificate
of Deposit (CD) ARM
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
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
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
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.
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Introductory
Rate ARM's
Most
adjustable rate loans
(ARMs) have a low introductory
rate or start rate,
some times as much
as 5.0% below the current
market rate of a fixed
loan. This start rate
is usually good from
1 month to as long
as 10 years. As a rule
the lower the start
rate the shorter the
time before the loan
makes its first adjustment.
Index - The
index of an ARM is
the financial instrument
that the loan is "tied" to,
or adjusted to. The
most common indices,
or, indexes are the
1-Year Treasury Security,
LIBOR (London Interbank
Offered Rate), Prime,
6-Month Certificate
of Deposit (CD) and
the 11th District Cost
of Funds (COFI). Each
of these indices move
up or down based on
conditions of the financial
markets.
Margin - The
margin is one of the
most important aspects
of ARMs because it
is added to the index
to determine the interest
rate that you pay.
The margin added to
the index is known
as the fully indexed
rate. As an example
if the current index
value is 5.50% and
your loan has a margin
of 2.5%, your fully
indexed rate is 8.00%.
Margins on loans range
from 1.75% to 3.5%
depending on the index
and the amount financed
in relation to the
property value.
Interim Caps
- All adjustable
rate loans carry interim
caps. Many ARMs have
interest rate caps
of six-months or a
year. There are loans
that have interest
rate caps of three
years. Interest rate
caps are beneficial
in rising interest
rate markets, but can
also keep your interest
rate higher than the
fully indexed rate
if rates are falling
rapidly.
Payment Caps
- Some loans
have payment caps instead
of interest rate caps.
These loans reduce
payment shock in a
rising interest rate
market, but can also
lead to deferred interest
or "negative amortization".
These loans generally
cap your annual payment
increases to 7.5% of
the previous payment.
Lifetime Caps
- Almost all
ARMs have a maximum
interest rate or lifetime
interest rate cap.
The lifetime cap varies
from company to company
and loan to loan. Loans
with low lifetime caps
usually have higher
margins, and the reverse
is also true. Those
loans that carry low
margins often have
higher lifetime caps.
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London Inter
Bank Offered Rate (LIBOR)
LIBOR is the rate on
dollar-denominated
deposits, also know
as Eurodollars, traded
between banks in London.
The index is quoted
for one month, three
months, six months
as well as one-year
periods.
LIBOR is the base interest
rate paid on deposits
between banks in the
Eurodollar market.
A Eurodollar is a dollar
deposited in a bank
in a country where
the currency is not
the dollar. The Eurodollar
market has been around
for over 40 years and
is a major component
of the International
financial market. London
is the center of the
Euromarket in terms
of volume.
The LIBOR rate quoted
in the Wall Street
Journal is an average
of rate quotes from
five major banks. Bank
of America, Barclays,
Bank of Tokyo, Deutsche
Bank and Swiss Bank.
The most common quote
for mortgages is the
6-month quote. LIBOR's
cost of money is a
widely monitored international
interest rate indicator.
LIBOR is currently
being used by both
Fannie Mae and Freddie
Mac as an index on
the loans they purchase.
LIBOR is quoted daily
in the Wall Street
Journal's Money Rates
and compares most closely
to the 1-Year Treasury
Security index. |
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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. |
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Interest Rate
Buydowns
The most common buydown is the 2-1
buydown. In the past,
for a buyer to secure
a 2-1 buydown 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 buydown 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. Buydown
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 buydowns
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 buydown 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 buydown
is the 3-2-1 buydown
which works much in
the same ways as the
2-1 buydown, with the
exception of the starting
interest rate being
3% below the note rate.
Another variation is
the flex-fixed buydown
programs that increase
at six month interval
rather than annual
intervals.
As an example, for
a flex-fixed jumbo
buydown 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%. |
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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 Eleventh 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
(COF) 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
three kinds of funds
and their costs are
added together before
a ratio is computed
rather than calculating
averages individually
for the three 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. |
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Graduated Payment
Method (GPM)
The GPM is another alternative
to the conventional
adjustable rate mortgage,
and is making a comeback
as borrowers and mortgage
companies seek alternatives
to assist in qualify
for home financing
Unlike an ARM, GPMs
have a fixed note rate
and payment schedule.
With a GPM the payments
are usually fixed for
one year at a time.
Each year for five
years the payments
graduate at 7.5% -
12.5% of the previous
years payment.
GPMs are available
in 30 year and 15 year
amortization, and for
both conforming and
jumbo loans. With the
graduated payments
and a fixed note rate,
GPMs have scheduled
negative amortization
of approximately 10%
- 12% of the loan amount
depending on the note
rate. The higher the
note rate the larger
degree of negative
amortization. This
compares to the possible
negative amortization
of a monthly adjusting
ARM of 10% of the loan
amount. Both loans
give the consumer the
ability to pay the
additional principal
and avoid the negative
amortization. In contrast,
the GPM has a fixed
payment schedule so
the additional principal
payments reduce the
term of the loan. The
ARMs additional payments
avoid the negative
amortization and the
payments decrease while
the term of the loan
remains constant.
The scheduled negative
amortization on a GPM
differs depending on
the amortization schedule,
the note rate and the
payment increases of
the loan. GPM loans
with 7.5% annual payment
increases offer the
lowest qualifying rate
but the largest amount
of negative amortization.
On a loan of $150,000,
with a 30 year amortization
and a note rate of
10.50% with 12.5% annual
payment increases,
the negative amortization
continues for 60 months.
The qualifying rate
is 5.75% and the negative
amortization is 11.34%
(approximately $17,010).
The note rate of a
GPM is traditionally
.5% to .75% higher
than the note rate
of a straight fixed
rate mortgage. The
higher note rate and
scheduled negative
amortization of the
GPM makes the cost
of the mortgage more
expensive to the borrower
in the long run. In
addition, the borrowers
monthly payment can
increase by as much
as 50% by the final
payment adjustment.
The lower qualifying
rate of the GPM can
help borrowers maximize
their purchasing power,
and can be useful in
a market with rapid
appreciation. In markets
where appreciation
is moderate, and a
borrower needs to move
during the scheduled
negative amortization
period they could create
an unpleasant situation. |
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Choosing The
Best Program
There isn't a single or simple answer
to this question. The
right type of mortgage
for you depends on
many different factors:
.
Your current financial picture.
.
How you expect your finances to change.
.
How long you intend to keep your house.
.
How comfortable you are with your mortgage
payment changing.
For example, a 15-year
fixed-rate mortgage
can save you many thousands
of dollars in interest
payments over the life
of the loan, but your
monthly payments will
be higher. An adjustable
rate mortgage may get
you started with a
lower monthly payment
than a fixed-rate mortgage
-- but your payments
could get higher when
the interest rate changes.
The best way to find
the "right" answer
is to discuss your
finances, your plans
and financial prospects,
and your preferences
frankly with a mortgage
professional. |
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