Adjustable Rate Mortgages - Determining Rates - part 2

by Dan Lewis

3. Cost of Funds Index - It gets a bit technical, but this index represents the rates being used by banks in Nevada, Arizona and California as an average.

4. LIBOR - Officially known as the London Interbank Offered Rate Index, LIBOR is a popular index upon which to base ARM rates. Now, you are probably wondering what London has to do with the United States real estate market. LIBOR represents the interest rate international banks charge to borrow U.S. dollars on the London currency markets. LIBOR rates move quickly and can result in unstable interest rate moves for your adjustable mortgage.

Why Indexes Matter

Indexes matter because they set the base of the interest rates charged on your loan. Assume you apply for an adjustable rate mortgage based on a LIBOR index. Assume the LIBOR rate is 2.2 percent when you apply. The 2.2 percent is your starting interest rate. If the LIBOR shoots up one percent in eight months, your loan will do the same.

Importantly, the index rate used for your loan is not the interest rate you will pay. Instead, you have to add the banks margin on top of the index rate. Most banks will charge two to three percent on top of the index rate. Using our LIBOR example, the initial interest rate of your loan would be 2.2 percent plus whatever the bank is using as a spread. Obviously, this means you need to closely read the loan documents to figure out how the game is being played!

Copyright (c) Dan Lewis

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