Adjustable-rate mortgages, known as ARMs, differ from fixed-rate mortgages in that the interest rate moves up or down. ARMs are tied to a number of indexes, which usually are published interest rates. The margin is the amount a lender adds to the index , usually two to three percentage points, to set the actual interest rate of the ARM.
The interest rate for an interest only loan is comprised of two components.
The Index + Margin = Full Indexed Interest Rate (THIS IS YOUR INTEREST RATE)
- Index refers to the particular financial marketplace interest rate, such as the T-Bill, LIBOR, of COFI Index.
- Margin refers to the profit margin a bank adds to the Index. The margin will vary but is based upon the overall risk of the loan (Consumer Credit Score) and the LTV (loan to value) of the property.
The margin usually always stays constant and does not change, while the index will change monthly, based upon interest rates in the financial marketplace.
The most common index for ARM adjustments is the one-year U.S. Treasury bill. The one-year bill has a yield very near that offered by the 30-year Treasury bond, which is used to set rates on 30-year fixed mortgages.
For interest only mortgage products the LIBOR index is becoming the most popular due to the lowest rates in the marketplace and the stability of the index.
Below are the current Index Rates as of September 2004:
1.60% LIBOR INDEX
1.76% T-BILL INDEX
1.87% COFI INDEX
Thus the best interest only product that will yield you the lowest interest rate today is the 1-month LIBOR ARM.
INDEX + MARGIN = Fully Indexed Interest Rate
1.60% + 2.00% = 3.60% Interest Only Mortgage Loan Interest Rate
The INDEX will change as the financial markets move interest rates, but the MARGIN will remain constant for the life of the loan.
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