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Indices Applied To Interest Rates Of Adjustable Rate Mortgages
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By Sebanti Ghosh

The Adjustable Rate Mortgage is a type of credit scheme in which the rate of interest payable varies with a previously decided economic index. The interest rate rises or falls in concurrence to the index. Consequently, the monthly amount payable by the borrower also fluctuates accordingly.

The most common indices to which the interest rates are connected include:

  1. Eleventh District Cost of Funds Index, or COFI
  2. London Interbank Offered Rate, or LIBOR
  3. Constant Maturity Treasury, or CMT
  4. Treasury Average Index, or MTA which is a 12 month moving average of 2-Year Treasury Constant Maturity Rate
  5. National Average Contract Mortgage Rate
  6. Certificate of Deposit Index, or CODI
  7. Bank Prime Loan Rate

The chosen index for an ARM should be such that its present value can easily be obtained from a published source. The lender must not have any control over the value.

There are three ways in which an index can be applied to an ARM interest rate. These are:

a) Directly applied. The rate of interest is identical with the index, which is the case only with the Contract Mortgage Rate index.

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b) Applied on a rate plus margin basis. In this case, the interest rate is equivalent to the sum of the chosen index and a particular margin fixed by the lending and the borrowing parties on a mutual contract and remains unchanged during the entire lifetime of the loan. For instance, if the rate is indicated as COFI plus 3%, then the index is COFI and 3% is the decided margin.

c) Applied on the basis of index movement: the mortgage initiates on a decided rate. Later it is regulated according to the movement of the index. Thus, only the subsequent adjustments and not the initial rates are tied to the index.

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This entry was posted on Friday, December 8th, 2006 at 3:19 am and is filed under Refinance. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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