Loan Choices

I worked in the mortgage lending division of a major bank for several years, and each day the bank's secondary department would distribute its daily rate sheets—all eight pages of them, with each page having about 15 different loan programs with different available rates. That's a lot of loan programs—in fact, a little too many, in my opinion. But in the world of marketing, it's all about distinguishing yourself.

There Are Really Only Two Types of Loan: Fixed and Adjustable.

That's it. There's not a lot more to it other than lenders offering different variations on a fixed-rate loan and an adjustable-rate loan. Fixed-rate loans can have terms as short as 10 years or all the way out to 40 years—or longer.

Adjustable-rate mortgages, on the other hand, can be based on a variety of indexes, some of which you may have heard of and some not. Adjustable rates are set using an index and a margin. There is a third category of loan program called a hybrid, but it's really not all that different.

A hybrid is actually an adjustable-rate mortgage with special terms attached.

The rates on adjustable-rate mortgages, or ARMs, can change. That's why they're called adjustable. Fortunately, however, you're aware of what those changes can be. An ARM is first based upon an index, the starting point for how your monthly payments will be calculated.

The most common indexes are the one-year Treasury index and LIBOR.

The Treasury index is the one-year Treasury note issued by the U.S. government. LIBOR stands for London Interbank Offered Rate; it is similar to our fed funds and discount rates.

Next, the margin is added to the index to give the interest rate on which the consumer's mortgage payment is based.

If the index is 4.5 and the margin is 2.75, then the interest rate would adjust to 4.5 + 2.75, or 7.25 percent. This is also called the fully indexed rate. On a loan amount of $200,000, the monthly payment would be $1,364.

When do ARMs adjust? At predetermined adjustment periods, most commonly every six months or one year. Whichever adjustment period is used, you'll know about it, as it's included in the terms of your original note.

A one-year adjustable will typically adjust once per year, a six-month ARM will adjust every six months, and monthly ARMs will adjust, well, monthly.

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