While no one can predict the distant future of mortgage rates with a high degree of accuracy, it's important to make an educated guess about ARM rates before you commit to one of these loans. ARM indexes, margins and caps determine future rate changes, and must be evaluated together when you shop for an ARM.Click to see today's rates (Sep 24th, 2017)
The most commonly-used ARM indexes are the T-Bill, CMT, COFI, LIBOR and MTA. Here's a quick rundown of these measures of financial activity. "Today" refers to February 24, 2017, when this post was written.
|Popular ARM Indexes|
Prices paid at federal auctions of 12 month Treasury bills, notes and bonds determine the value of this index. Its current level, as of this writing, is .78 percent. During the last 20 years, it's been as high as 6.24 percent and as low as .02 percent. Its median value over the last 20 years is 1.43 percent.
So if you have an ARM with a 2.5 percent margin, your interest rate could go as low as 2.52 percent, and as high as 8.74 percent, if the index continues the pattern it's established over the last 20 years. The median rate, which you might think of as a more likely scenario over time, would be 3.93 percent.
Of course, these rates may be adjusted according to the loan's caps and floors, which limit how high and low the rate can go during the loan's lifetime. If your loan has a three percent floor and an eight percent cap, your range of rates will be smaller.
The one-year Constant Maturity Treasury, or CMT, is similar to the T-Bill index -- it's derived from auction prices of government-backed debt. The Federal Reserve Board calculates it from the monthly average yield of a range of Treasury securities, adjusted to a one-year term.
Currently, it's at .81 percent. Its lowest value in the last 20 years was .08 percent, and its highest level was 6.44 percent. Its median level during that time was 1.60 percent.
With a 2.5 percent margin, the lowest rate (excluding caps and floors) would have been 2.58 percent, and its highest would have been 8.94 percent. The median would be 4.1 percent.Click to see today's rates (Sep 24th, 2017)
The 11th District Cost Of Funds Index, or COFI, reflects the rate savings institutions pay depositors. It's a lagging index, based on costs for the previous month. The COFI tends to move a little more slowly than some of the other indexes. That can be good when rates are rising.
As of this writing, the COFI is at .599 percent, nearly matching its all-time low value of .598 percent. Its highest value in the last 20 years was 5.617 percent. Its median value is 2.308 percent.
With a 3.0 percent margin (COFI loans tend to have higher margins), your rate today would by 3.599 percent. If the index hits its highest level on 20 years, your rate could rise to 8.617 percent. If the COFI settles around its median, you'll pay 5.308 percent.
The six-month London Interbank Offered Rate is one of the most commonly-used indexes. It reflects the rate that European banks charge each other for six month loans.
There are also one month, three month and one-year LIBOR indexes, so make sure you know if the LIBOR loans you're comparing actually have the same index.
Currently, the 6-month LIBOR rate is 1.34 percent. Its lowest level in the last 20 years was .323 percent. It's highest value was 7.064 percent, and the median value is 1.903 percent. With a 2.5 percent margin, your best case rate would be 2.323 percent, your worst case is 9.564 percent, and the median is 4.403 percent.
Note that the LIBOR range is wider than the other indexes, so your loan could be more volatile -- pay attention the caps and floors that could narrow this range a bit.
The Monthly Treasury Average, aka the 12 Month Moving Average Treasury (MAT) Index, is a close relative of the CMT. In fact, you calculate it by averaging the last 12 values of the monthly CMT.
Because it's an average, this index tends to move more slowly. That can be good in a rising rate environment, and less so when rates fall.
The current value for this index is .638 percent. If you have a 2.5 percent margin, and your rate were adjusting as of this writing, your new rate would be 3.138 percent, subject to the loan's caps and floors. The lowest value for this index in the last 20 years is .113 percent (your rate would be 2.613 percent, subject to the loan's floor).
The highest is 6.128 percent (your rate would be 8.628 percent, subject to the loan's caps). The median value of this index is 1.872 percent (4.372 percent with a 2.5 percent margin).
When comparing ARM loans, you look at several factors:
Most people who choose ARMs try to match the fixed-rate period to the time they intend to own the home. They don't really plan to have this loan when it begins resetting.
If that's you, your main concern will be getting the best rate for what you wish to pay.
However, you may end up keeping the house longer than you expect, and the future movements of the interest rate should be considered. Know where your payment could go in Year Six of a 5/1 ARM in case you need to actually pay it.
In that case, a loan with a two percent cap on the initial adjustment could be a much better deal than one with a three percent initial adjustment cap.
Current ARM rates are a bargain, with some indexes very near their historic lows. However, in a rising rate environment, it's important to choose an ARM that offers some degree of future safety in addition to a low interest rate today.Click to see today's rates (Sep 24th, 2017)
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