OT: ARM /subprime / basic mortgage question

Anonymous · ‎01-22-2008

Now, I apologize if this is a completely naive question, but I'm trying to learn me something

I need some help understanding how ARMs work. I understand that after a given period of time, they "adjust" to a new rate, and, therefore, a new payment. How is that rate determined? Is it Prime plus whatever amount you agreed upon going in? Do different banks/credit unions offer better options (amongst ARMs, I KNOW they have better options than ARMs)? Does the Federal Reserve's continued cutting of interest rates affect them if they are resetting this year? Are these subprime mortgages balloon mortgages and that's why their payments are skyrocketing? Or did they have ARMs that readjusted after just one or two years and were prime plus a lot?

Anonymous · ‎01-22-2008

I think the answer to all of your questions is yes.

An ARM is like a variable rate credit card after the teaser rate expires. The rate you pay is based on an index, such as Prime or LIBOR, plus a certain percent. This is spelled out in the mortgage documents that most people don't read when they buy a home.

We're in a subprime mess because (and please, let's not get into the discussion of whose fault it is -- lenders for being stupid and handing out mortgages to people who couldn't pay them back, or borrowers who were stupid and didn't understand what they were getting into) the intro rates were low, and now they're not. Even with the interest rate cuts (which lowers Prime), mortgage payments are drastically higher than they were for the first year or two of home ownership.

I admit it -- I got an ARM when I refied last time. But I got a 10/1 ARM, meaning the rate doesn't reset for 10 years. I figured that by 2015, I would have either sold the house or interest rates would have gone up and then come down.

Anonymous · ‎01-22-2008

This is from Shane's sticky about mortgage abbrieviations:

ARM: Adjustable Rate Mortgage is a mortgage that will have a fixed rate for a set period of time and then the rate is adjusted. The fixed period can be as short as 1 month or as long as 10 years. The rate will normally be adjusted either once a year or twice a year. There is one type of mortgage where the adjustment period is monthly. All ARM’s are based on an index. The following are the common indexes:

1) 1 year Treasury Bill is the index used for all FHA ARM mortgages and many conforming ARMs

2) LIBOR: London Interbank Offered Rate is the other major index used on conforming mortgages. It is also the index that all subprime ARMs are based on. Subprime mortgages will use the 6 month LIBOR but conforming ARMs can use anything from the one month LIBOR up to a 1 year LIBOR though they will generally only use either the 6 month LIBOR or the 1 year LIBOR.

3) COSI: Cost of Savings Index is based on the 11th District Federal Home Loan Bank in San Francisco. COSI loans are always Option ARM mortgages.

4) CODI: Cost of Deposits Index is similar to COSI except it is only offered by World Savings to separate themselves from the other Option ARM lenders.

5) COFI: Cost of Funds Index is similar to COSI and CODI.

6) MTA: Monthly Treasury Average is another index that is used strictly by Option ARM lenders