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John Moran

Frequently Asked Mortgage Questions Part 12

Tuesday, August 6, 2013 - Article by: John Moran - Simplify Mortgage - Message

This is the twelfth installment in an ongoing series on mortgage basics. On my mortgage website, I cover a host of topics on my frequently asked questions page. Since this is the most popular page on my site, I thought it might be a nice way to begin my blog. You can find the entire list of FAQs here: Arizona Mortgage Pro FAQs. I will continue this series covering one topic per post.

What is an ARM and should I choose one for my home purchase or refinance?

ARM stands for Adjustable Rate Mortgage. This designation can actually be a bit misleading. Most ARMs are fixed loans for a certain period of time and then they adjust at specific intervals, not solely adjustable as the name suggests. Most ARMs are shown in the following format: 3/1. The two figures on either side of the / stand for adjustment periods for the loan. The first figure is the time period for which the loan is fixed. In a 3/1 ARM, it is fixed for 3 years. In a 5/1 ARM, it will be fixed for 5 years. The number behind the / is the amount of time between adjustments. For both the 3/1 and 5/1 ARM, the adjustment period is 1 year. So now you know that the 3/1 ARM is fixed for 3 years and will adjust once a year after that. Let's move on to how the loan will adjust. After the fixed period of an ARM, the rate on the loan will adjust according to an index plus a margin. The margin is determined at the beginning of the loan and remains constant over its life (the average margin is about 2.75%). An index is a published number or percentage that cannot be affected by one person or entity and an ARM will be specifically tied to one. Some common examples of indices are the LIBOR (London InterBank Offered Rate), the One Year Treasury Security, and the COFI (Cost of Funds Index). These indices are all widely available and not subject to change solely by any person or entity. They are generally affected by the economy and supply and demand. So to figure out what an ARM's rate is after the fixed period, you simply add the margin on the loan to the current index it is tied to. Another component of an ARM is a cap. In order to prevent an extreme rate jump if one of the indices were to suddenly move very high, ARMs have 3 different caps, usually written in 2/2/5 notation (sometimes written in 2/6 notation, meaning that the first two digits are the same). The first digit refers to the maximum percentage the loan can adjust the very first time it adjusts (right after the fixed period is over). In this case, 2/2/5, the loan can't adjust more than 2% on its first adjustment. The second digit refers to maximum percentage that the loan can adjust each adjustment period (usually, but not always, one year) after that. In this case, 2/2/5, the loan can't adjust more than 2% for each adjustment period after the first. The final digit refers to the total amount the loan can ever adjust or lifetime cap. In our example, the loan cannot adjust more than 5% over its start rate over the life of the loan. So to recap, the maximum amounts an ARM with 2/2/5 caps can adjust is 2% the first adjustment, 2% any adjustment after that, and 5% over the life of the loan. Now that you know all about ARMs and how they adjust, should you choose one for your home? If you know you will only be in your home for a certain number of years, it makes this question fairly easy to answer. Suppose you know you are only going to live in your current house for four more years because you are getting transferred for work or you know you will outgrow your home. A 5/1 ARM would suit your needs perfectly and save you money because it will be fixed for five years, of which you only plan to stay four. If you plan to stay for longer than five years, the question becomes more complicated and you will have to look at other factors. One important factor is how low or high rates are currently compared to historically. If rates are low historically and you plan on being in your home for quite a while, a fixed rate mortgage is likely your best plan. If rates are high historically, you may want to start with an ARM to save some money short term and refinance when rates drop into a range you are more comfortable with. As always, if you have any questions on ARMs or any other mortgage issue, please call or email.

Thanks for reading my blog!

John Moran

Senior Loan Officer

3920 S Rural Rd #110 Tempe, AZ 85282

Direct: 480-300-4520

Fax: 602-904-7741


NMLS#1059293 AZ#LO-0924433

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