What you ought to know (#11)...

Last week you mentioned "margin" in your discussion of indexes, what is a "margin"?

A margin is basically the lenders profit. To make sure that the lender´s expenses are covered, the lender will add a margin to the index.

Margin + Index (discussed in last week´s letter) = Interest Rate

When you get an adjustable rate mortgage (ARM), you are tied to a certain index. For this example, let´s say it is a LIBOR index which is at 5%. If you have a 2% margin, your interest rate on that loan will be 7%. It gets "interesting" when your adjustable rate gets ready to adjust. Again, using the same example, let´s say your adjustable rate loan is fixed for the first 3 years, then can adjust every year after (a 3/1 ARM). At the 3 year anniversary date, the LIBOR index is now at 6.5%, so your new interest rate will be 8.5%.

What would happen if the index jumped up to 11%? Would your new interest rate be 13%? Maybe, but most likely not. Built in to your adjustable rate loan are Rate Caps. Rate Caps limit how high your interest rate can adjust each adjustment period. If you have a 2% rate cap, then the maximum your rate (in the above example) would be 9% (you started at 7%, plus the 2% rate cap). Some ARM´s have lifetime caps, which means the rate can never go higher than the index plus the maximum cap. Others have initial caps, which determine the maximum amount the rate can adjust during the first adjustment period.

Bottom-line...if you are looking at an adjustable rate mortgage, you need to understand where your starting rate is, and how much it can adjust. Contact Arrowhead Home Loans to determine what program is best for you, over the life of your loan.