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Fri, 07 Mar 2008 15:03:00

The scoop on ARMs: hybrids, rates and caps

Mortgage News from Quicken Loans

The term ARM (adjustable-rate mortgage) is in the news a lot recently, yet many people don't understand what ARMs really are. Here, we offer an explanation of how ARMs work and the different ARM choices.

First, all ARMs are not subprime mortgages. The term "subprime" is given to mortgages designed for borrowers with less than average qualifications - credit, income, assets. Many subprime mortgages were ARMs, but the opposite is not true - most ARMs are not subprime.

The most common and predictable of all ARMs is the hybrid ARM. The term "hybrid" refers to the mortgage's blend of both fixed and adjustable rates. Hybrid ARMs are fixed for a specified period (determined by the borrower, usually 3, 5 or 7 years) and then can adjust at a designated time. This date is known as the reset date. After the reset date, a hybrid ARM can adjust up or down, determined by the index it is based on. Common indices are 11th District Cost of Funds Index (COFI), London Interbank Offered Rate (LIBOR) and the 12-month Treasury Average Index (MTA). This is all information a borrower would have prior to agreeing to an ARM.

Keep in mind that ARMs, even hybrid ARMs, have interest rate caps. This limits the amount at which how much and how often the rate can change. The initial adjustment is how much it can change at the reset date. The second cap is how often the rate can change, typically every 6 months or 1 year. The last cap is how much, in total, the ARM rate could change over the life of the loan.

ARMs and hybrid ARMs are popular due to the typically low interest rates they carry. Depending on a borrower's goals, an ARM could give a borrower significant payment and interest savings over a certain period of time. Americans refinance every 4 years on average. If a borrower plans to refinance or sell their mortgage within 7 years, thus never reaching the reset date, an ARM will offer increased monthly cash flow when compared to a 30-year fixed rate.

This article is reprinted by permission from Quicken Loans © 2008 Quicken Loans Inc. All rights reserved.

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