# ARM discussion - bobbysillers.com by jizhen1947

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```									Adjustable Rate Mortgages [ARM]

Does NOT adjust every year! It is fixed for the first 3-5-7-10 years of the loan, then
adjusts [typically annually] every year after that.

IE: A “7/1” or a “7 year ARM” is fixed for seven years, and then adjusts every year
after that.

Factors affecting the starting rate [and desirability] of an ARM:

 Rate: [Start Rate] a lower rate will cost more in points, like any other loan
 Term: Typically an ARM with a longer fixed period will cost more [have a
higher rate] than a shorter term. 10 year ARM rates are typically higher
than 5 year ARM rates because the lender has to guarantee that fixed rate
for a longer term. If rates go UP in that time the lender gets hurt.
 Index: What financial measure [Prime rate? LIBOR? Treasury, Cost of Funds
Index {COFI}?] will the new rate be based on once the fixed period is over?
LIBOR [London Inter-bank overnight rate – which is sort of like our Fed
funds rate] is considered ‘jumpier’ or faster to change, than some other
indexes. If you think rates are going DOWN [in your variable period] you
might choose a LIBOR based ARM since your rate might go down faster
than if you used some of the other indices.
 Margin: You add the ‘margin’ to the ‘index’ to find the rate in the variable
period [i.e.: - years 8 through 30 on a 7 year ARM]. If you have a “WSJ
prime + 2.25” that means your annually recalculated rate will be found by
looking at Prime Rate in the Wall Street Journal and adding 2.25%. If prime
were 3.5%, add 2.25% and your rate for that year would be 5.75%. Margins
are usually between 2% and 3.25% - a lower margin will cost more on the
initial loan.
 Terms: “2-2-6”, or “5-2-5”
o Digit 1: Once the fixed period is over how much can my rate go up or
down, compared to my starting rate, in the first year after the fixed
period [say ‘year 8’ on a 7 year ARM]? I often call this the “catch-up

Bobby Sillers – Park Cities Mortgage – www.bobbysillers.com W/M 214-525-0301 bsillers@ntfn.com
year”. A “2-2-6” normally costs more than a 5-2-5, because there is
not a big ‘catch up’ factor for the lender.
o Digit 2: After the catch up year, how much can my loan rate go up or
down, until and including the 30th year? In both terms above, in years
9-30 on a seven year ARM, the rate could only go up OR down a
maximum of 2% each year.
o Digit 3: How much can my loan go up or down, over the life of the
variable term [years 8-30 on a 7 year ARM]? If you have a 5-2-5 ARM
that starts at 6.125%? The rate you pay could never go over 11.125%
or under 1.125% over the variable term of the loan. [Exception: most
loans say “You can’t go UNDER the index” – which means if Prime or
LIBOR is 1.75% - you can’t go below your index for your rate].

   Amortization – Interest Only ARMS typically have higher rates, but will
mean a LOWER monthly payment [simply because they are interest only.]
o Borrower now must typically qualify on the ‘fully indexed rate” [see
last section of this paper]

 Pre-payment penalty – Like most loans if the borrower says “I know I will
have to pay an x% penalty if I pay off this loan early” – will get a lower rate
because the lender gets a longer guaranteed stream of income. I have seen
many borrowers come to me for refinance, and find out they have a pre-
payment penalty – No wonder their rate seemed so good when they got
the loan!

Why should you get an ARM?
The rates are lower!
Who should get them?

Bobby Sillers – Park Cities Mortgage – www.bobbysillers.com W/M 214-525-0301 bsillers@ntfn.com
 People who KNOW they will be out of the loan in the fixed period “Johnny
is a freshman at St. Marks, and we are moving to Bolivia when he
graduates”…THEY can have a 5 year ARM.

 Persons who have the resources to use the ARM as a weapon in their
financial toolset. And won’t get burned if the rates go up.

 An interest-only ARM typically allows principal reductions – that are
immediately recognized [meaning their payment goes down after they send
in the ‘extra’ principal.]. ‘Lumpy income’ borrowers like this feature.

Who should NOT get them?

 People who ‘need’ a lower payment to afford the property – and could not
stand the impact if the rate goes up after the fixed period.

Qualify on ‘fully indexed rate” Monday, July 18, 2011

ARMS –used- to allow one to qualify with the lower payment of an ARM. Probably
6-9 months ago that changed. Most lenders make the borrower qualify on the
‘fully indexed, amortized rate”. What does that mean?

A \$ 600,000 loan on a 4.5% interest only ARM would cost a borrower \$
2250/month [\$ 600,000 * 4.5% / 12 months]. Lets assume taxes and insurance are
\$ 1500/month and borrower has \$500 car payment. \$ 2250 + \$ 1500 + \$500 =
\$ 3750 / month in debt. If the lender is allowing a maximum 45% “DTI” {“debt-to-
income} the borrower needs to make \$ 8333/month or \$ 100,000/year to qualify.
{ \$ 3750 / 45% = \$ 8333./month}. That was the OLD way….

The NEW way? Using a fully indexed, amortized rate? If that ARM is a “5-2-5”
ARM [ if you don’t understand that see the bottom of page 1] . The fully indexed
rate is the 4.5% start rate plus the 5% maximum it could rise, and not at the
‘interest only rate’ but at the AMORTIZED [principal AND intrest] rate.

So that \$ 600,000 loan at 9.5%? That will cost \$ 5045.13/month – plus the taxes
and insurance of \$ 1500 plus the car of \$ 500?
Total debt is now \$ 7045.13/month. Divide by that 45% debt ratio [DTI] and the

Bobby Sillers – Park Cities Mortgage – www.bobbysillers.com W/M 214-525-0301 bsillers@ntfn.com
borrower must earn \$ 15,655/month times 12 = \$ 187,870/year to qualify for the
loan.

Summary? ARM’s are still great tools…but simply to use one to get someone to
qualify if they don’t have the income is not one of the applications. There WERE
good reasons to use this – if someone’s income was definitely going up. That is
not an option right now.

Notes: “APR” on the Truth –in-Lending [TIL] at a loan closing can be confusing. It is
usually BELOW the interest rate on the loan. Why? The calculation takes the index
and margin TODAY to calculate the APR. You will be [seem?] smart if you know
this @ your closings. On a 3.5% ARM today you would expect the APR to be
perhaps 3.6% to 3.8%. But 1 year LIBOR today is .76%, plus a margin of 2.25% -
your APR is probably going to be around 3.2 to 3.4%...which is less than your note
rate. [These figures are from May 9, 2011].

===================================================================

http://www.bankrate.com/rates/interest-rates/1-year-libor.aspx

Easy place to find the LIBOR index [on 5/9/2011 it was 0.76%]

Bobby Sillers – Park Cities Mortgage – www.bobbysillers.com W/M 214-525-0301 bsillers@ntfn.com

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