HOUSE Magazine, March/April 2005 By Michele Francis

Hybrid ARMS are a good choice for homebuyers who are not committed to staying in the house long term. If they know up front that they probably will sell the house in 5 years, why should they opt for the higher interest rate that comes with the stability of a 15 or 30 year fixed rate loan?

But what are the best types of ARM’s for those buying vacation homes or investment rental properties? For these buyers, there are other adjustable rate mortgages based on other indices. The names of these types of loans may be familiar but the indices on which they are based are often a mystery to mortgage shoppers.

To begin with, an index can be defined as an independently published economic indicator. There are a variety of commonly used interest rate indices which lenders use to establish the interest rate on adjustable rate mortgages, and ARM rates follow the movement of these indices. The lender will add a specified number of percentage points, called a margin, to the index to establish the actual ARM interest rate. Typically, these rates are significantly less than those of fixed rate type mortgages.

Let’s look at a few.

London Inter Bank Offering Rates (LIBOR)
This index is the average interest rate offered by certain London banks on U.S. dollar deposits. ARM’s based on the LIBOR index offer very low initial rates (usually 1 month, 3 months, 6 months, or 1 year) and protect the borrower from extreme jumps in rate by imposing periodic and lifetime rate caps. The Wall Street Journal posts the LIBOR compiled by the British Bankers Association (BBA), published at 11:00 AM daily. Fannie Mae’s LIBOR is posted on the last business day of each month.

11th District Cost of Funds Index (COFI)
This is the most stable of the indexes. It is the weighted average of the interest rate for the 11th Federal Home Loan Bank District, consisting of the banks headquartered in Arizona, California and Nevada. Because it is based on savings accounts, it moves slower than other rates, making it a great option when rates are climbing rapidly.

12 Month Treasury Average Index (12-MTA)
This is based on the average yield on Treasury Securities adjusted to constant one year maturity. Because it is a 12 month average, this index is also more stable because market conditions take longer to affect it.

Constant Maturity Treasury (CMT)
This is the most volatile of the four. CMT indexes will react quickly to market conditions. They are based on the daily yield curve and do not have a long term average to stabilize them.

The great feature about many loans based on these indexes is that there are four payment options. The client can pay the minimum amount due (*not advised, may result in deferred interest), the minimum amount due plus interest owing for the current month (interest only), full principal and interest to amortize the loan fully within the original term, or principal and interest in an amount that would fully amortize the loan over an initial 15 year term. Depending upon vacancy or a tax advisor’s recommendation, the client has choices.

Other attractive aspects of this program include: the availability of a 40 year term; assumability, subject to fees and conditions; low documentation requirement for income; extended rate lock options with loan amounts up to $2,500,000.00.

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