As if there were not enough decisions to make when you are purchasing a house and getting a mortgage, lenders now have such a wide rang of ARMs (adjustable rate mortgages) and the borrower even has to choose the index upon which the ARM will be based!

The index of an ARM (Adjustable Rate Mortgage) is the financial standard upon which the adjustments will be made. Various indices are used, including government treasury instruments, the Fed Fund rate or LIBOR.

The basic idea of an ARM is that the interest on the loan is adjusted up or down, periodically, based on a chosen signal interest rate that is indicative of interest rates in general. If your index is CDs, and CDs go up, your interest rate goes up. ARMs have rate adjustment caps, which means that the rate on your home loan will only go up at certain intervals (every three or six months, for example), so that when the CD rate goes up, you may not have an increased rate for a few months, if your rate just adjusted recently. Of course, the opposite can happen, and if your rate has just been readjusted at a high rate, and then the index moves down, you will not be able to take advantage of that until your next readjustment period.

ARMs can be tied to any number underlying instruments, for example the 90 day U.S. Treasury Bill. The Fed Funds rate is another very popular basis for ARMs. LIBOR, the London Interbank Offered Rate, is a very popular index, and is the rate used by large global companies to borrow.

The index is a personal choice, based on the individual loan, and how the borrower feels interest rates will behave. Adjustable rate home loans that use CDs as the reference rate tend to adjust more quickly. Rates on Treasury instruments such as the Treasury Bill move more slowly than CDs, and so will react more slowly to interest rate changes. One of the fastest indices to move is the LIBOR, so if you want your interest rate to move frequently, because you think rates are falling, this is a good choice.

As we said, new products are introduced each day, and one of the newest it the option ARM, which allows the borrower to pick how much he wants to pay on his home loan each month. Of course, there is a minimum, usually the amount of interest, so the bank can guarantee its return, and then the balance goes toward the loan. Be warned that minimum payment option can result in an increasing, rather than decreasing mortgage, a concept known as negative amortization.

This is a lot of information for the borrower to digest, and the best solution is to consult with a professional mortgage broker who can explain it all and recommend the best course for you.

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