An index is the published interest rate to which the interest rate on an Adjustable Rate Mortgage (ARM) is tied. Some examples of common indexes are: LIBOR, PRIME, COFI, MTA, etc...
Remember the margin stays the same but the index may fluctuate on a monthly basis. So when you refinance you can negotiate your margin and the index type. Once decided, the index type never changes.
Research the historical trends on the various ARM indices to see which tend to change less over time. Also, if your ARM is about to adjust after a fixed period, start watching the index so you'll have some idea what your new rate will be. If it will be too high, you may wish to consider refinancing before the adjustment date.
After choosing your index there are caps that are then put in place to make sure your rate cannot go past a certain point no matter what your index does. It should be known these caps are usually quite high.
The rate against which lenders quantify the differences between the present interest rate on an adjustable rate mortgage and that earned by other investments, which is then used to adjust the interest rate on an adjustable mortgage up or down.
When choosing an Adjustable Rate Mortgage (ARM), it is recommended to research on the underlying index. Some indices tend to adjust faster and more often than others. As a mortgagor, a less volatile index is most preferred.
While the index that you choose is very important to you there are also many other factors to consider when obtaining an ARM (Adjustable Rate Mortgage) loan. You must decide what kind of ARM loan you would like. Do you want an ARM that is fixed for 1 year, 3 years, 5 years 7 years, etc...? What are your plans for th property and what is the reasoning for financing the property? Do you just plan on keeping the house a couple of years and moving on? Are you just looking to reduce your payments for a couple of years to help you get control of your finances? These are all questions you should be asking yourself so that you are not only able to pick out the right ARM loan but the right index too.
The index you choose also should be determined by what type of market that you are in as well. If we are in an increasing market you may want to go with the MTA as it is a 12 month average of the LIBOR so it will always be lower in the increasing market and less volatile. While if we are in a decreasing market you may want to choose the LIBOR over the MTA because the LIBOR will lower more quickly than the MTA.
Remember the index always changes and your margin never changes. When taking a loan make sure you are comfortable with the volatility of the index.
PRIME is a actually short for the Federal Prime Lending Rate. It represents an interest rate in itself. The prime rate is also indexed, and used to determine the interest rate you will be charged when you apply for a Home Equity Line of Credit.
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Information listed above is to be used for educational purposes only and is not guaranteed