Monday, April 14, 2008

A Silver Lining - ARMs at same levels 12 month ago

According to JP Morgan about $500 billion of adjustable-rate mortgage loans are due to reset this year and next. With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. After a period of fixed rates the interest rate adjustments kick in. The most common ARM type loans are 2-28 and 5-1 with initial rates fixed for 2 and 5 years respectively. The new interest rate is computed by adding a predetermined fixed margin to a selected index rate. The margins remain fixed for the term of the loan and are not impacted by the financial markets and movement of interest rates. In addition most ARMs have interest rate caps to protect from enormous increases in monthly payments. The indexes are subject to interest rate movements and therefore pose the biggest problem for adjustable rate mortgages.

Thanks to the Federal Reserve cutting the target rate aggressively from 5.25 to 2.25 since September of last year, interest rates at ARM indexes have come down significantly. A year ago a one-year ARM averaged 5.43 percent and a 5/1 ARM was at 5.88 percent. According to HSH Associates the national monthly average of a 1 year ARM is now at 5.8 percent. The silver lining - this should help to mitigate the impact that adjustable rate mortgages have on the number of foreclosures.

ARM indexes:
Constant Maturity Treasury (CMT or TCM)
Treasury Bill (T-Bill)
12-Month Treasury Average (MTA or MAT)
Certificate of Deposit Index (CODI)
11th District Cost of Funds Index (COFI)
London Inter Bank Offering Rates (LIBOR)

CMT, COFI, and LIBOR indexes are the most frequently used. Approximately 80 percent of all the ARMs today are based on one of these indexes.
After rising in February and March ARMs are finally going down again.

source: Types of Mortgage Loans

source: HSH Associates

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