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Adjustable Rate Mortgages The information which follows has been adapted from the "Consumer Handbook on Adjustable Rate Mortgages" published by the Federal Reserve Board and the Office of Thrift Supervision.

 An adjustable rate mortgage (ARM) is a mortgage for which the interest rate is not fixed, but changes during the life of the loan in line with movements in an index rate. Lenders generally charge lower initial interest rates for ARMs than for fixed-rate mortgages. The lower rate may provide you with lower cash outlays in the first year of the loan and in the years thereafter should rates remain relatively stable or decrease. Additionally, you may be able to qualify for a greater amount under an ARM program than a fixed rate program.It is also possible that interest rates may increase, leading to higher monthly payments in the future. You face a trade-off; you obtain a lower rate with an ARM in exchange for assuming more risk. The terms which follow will help you understand some of the important concepts involved with ARMs.

Adjustment Periods The interest rate and monthly payment of ARMs change periodically, such as every year, every three years, or every five years. Other ARM's have an initial fixed rate period of 5, 7 or 10 years and change annually thereafter. The period between one rate change and the next is called "the adjustment period." Thus, a loan with an adjustment period of one year is called a one-year ARM, and the interest rate can change once every year.

Index ARM interest rate changes are tied to changes in an "index rate." These indexes usually go up and down with the general movement of interest rates. If the index rate moves up, so does your mortgage rate in most circumstances, and you will probably have to make higher monthly payments. On the other hand, if the index rate goes down, your monthly payment may go down. Lenders base ARM rates on a variety of indexes. The most common are US Treasury securities. Another index is the national or regional average cost of funds. You should ask what index will be used and how often it changes. Also ask how it has behaved in the past and where it is published.

Margin To determine the interest rate on an ARM, lenders add to the index rate a few percentage points called the "margin." The amount of the margin can differ from one lender to another, but it is usually constant over the life of the loan. Therefore, in comparing ARMs, look at both the index and margin for each plan. Some indexes have higher average values, but they are usually used with lower margins. Be sure to discuss the margin with your lender.

Initial Rate Some loans offer initial ARM rates that are lower than the sum of the index and the margin. Sometimes you can buy down the initial rate by paying "points".

Interest Rate Caps An interest-rate cap places a limit on the amount your interest rate can increase. Interest caps come in two versions:

Periodic caps, which limit the interest-rate increase from one adjustment period to the next; and
Lifetime caps, which limit the interest-rate increases over the life of the loan. By law, virtually all ARMs must have an overall cap.

Amortization Tables The amortization tables allow you to see a summary of unpaid principal, interest paid and initial monthly payment for each year of the life of your loan.

Appraised Value The appraised value is the market price of the home you wish to buy. In some cases you may pay more or less than the appraised value of the home, but unless stated otherwise you may assume that the appraised value of the home is also the purchase price. This figure is used to determine your down payment and whether or not you'll be required to pay mortgage insurance.

Annual Percentage Rate(APR) The cost of credit on a yearly basis, expressed as a percentage. Required to be disclosed by the lender under the federal Truth in Lending Act, Regulation Z. Includes interest rate, points and certain finance charges.

Appreciation Rate The market value of your home may increase over time. The appreciation rate is a way to judge how quickly the home's value is increasing. You may estimate this figure by calculating the percent increase of the home's value over a period of one year. For example, suppose that you own a $100,000 home and that the value of your home increases by roughly $3,000 per year. In this case, the home's appreciation rate would be 3% because the home's value has grown by 3%, from $100,000 to $103,000.

Closing Costs Closing Costs include, but are not limited to, the appraisal fees, underwriting or other lender fees, title insurance, and escrow fees.

Cost Analysis In most of our calculation programs, we usually include these items as costs:

The interest you pay
The discount points you pay
The closing costs you pay
The property tax and property insurance you pay
The mortgage insurance you pay

We usually include these items as benefits:

The tax savings you receive from paying interest and discount points
The tax savings you receive from paying property taxes
The appreciation (increase in the home's value) you gain
The amount of principal you repay with each payment

In order to determine which of your options will cost you the least amount over the period of time you'll own a home, we compute for you the total of the costs and benefits you'll pay or receive. The calculation is a bit tricky because you'll receive or pay the items above at various times: immediately, monthly, yearly, or at the time you sell.The time at which you pay a cost or receive a benefit can make a big difference. For example, receiving $5,000 right now is worth more to you than receiving it 3 years from now. You can invest the $5,000 and earn interest over the 3 years. In the same way, if you can avoid paying a cost for a while, you can invest that amount now and earn interest on the money.We use the interest rate you probably receive on your savings and adjust each of the items above, figuring out what each cost or benefit would be worth to you today. We can then sum up all the numbers and give you the total cost of each option as if you paid it today.The option with the lowest cost is usually the best for you.

Discount Points One discount point is equal to 1% of your loan amount. On a 100,000 mortgage loan, 1.5 discount points equals $1,500 ($100,000 x 1.5%). Discount points are paid to obtain a lower interest rate on your mortgage. The more points you pay, the lower the rate you may obtain. The longer you own your property and continue to pay on the loan, the more likely it will be that paying points will be advantageous for you. If you intend to hold the mortgage for only a short period of time, the cost you pay up front may exceed the benefit you will receive from obtaining a lower rate.

Equity Your equity in your home is the difference between the remaining balance owed on your mortgage loan and the appraised value of the home. Your equity increases if your home increases in value and as you make your monthly payments of principal and interest. The principal portion of your payment is used to repay the amount you borrowed.

Homeowner's Insurance A lender will require you to obtain homeowner's insurance on your property. In some of our calculation programs you must indicate the amount you expect to pay each year to insure your home. Your lender or real estate agent may be able to help you estimate typical payments in your area.

Tax and Insurance Escrows Each monthly mortgage payment will include one-twelfth of your yearly tax bill and your yearly homeowner's insurance premium.As an example, if your property taxes are $2,000 per year and your insurance premium is $600, one month's worth (1/12th) of each is $167 and $50.The lender collects these amounts with your monthly payment and holds them in a special account ("an escrow account"). The money in the account will be used to pay your taxes and insurance premiums when they become due.Here's why taxes and insurance are collected along with your principal and interest payments:If your taxes are left unpaid, your municipality or other taxing authority can foreclose on your property in order to obtain payment. If the foreclosure is successful, the lender could lose it's collateral. In other words, if you're not making your payments, the lender might not be able to recoup its loss. The tax lien has priority over the mortgage lien. The lender also wants to make sure your insurance premium is always paid. If your property is destroyed by a fire, the insurance proceeds can be used to rebuild the house or repay the loan.

LTV (Loan-to-Value) This percentage is computed as follows: Loan Amount/Appraised Value of the Home. As an example, a loan of $80,000 on a home valued at $100,000 has an "LTV" ratio of 80%.

Mortgage Insurance Mortgage insurance insures the lender will be protected from loss should you cease making payments. You will not be required to pay mortgage insurance if your down payment is 20% or more of the appraised value of your home.

Origination Fees This fee is usually 1% of the loan amount and pays the lender for processing and originating your loan. As an example, the 1% origination fee on a $100,000 mortgage loan is $1,000 .

Prepaid Interest This is the amount of interest you owe from the day your loan funds to the end of the month. Here's an example: If you close on the 15th of January and your interest is $21 per day, you would pay $336 (16 days at $21 each day) for interest for the month of January. Your first payment would be due on March 1st and would pay principal and interest for the month of February.

Property Taxes This is the amount you expect to pay each year in property taxes. The amount you pay varies significantly from area to area and is usually a set percent of your property's value. If you need help estimating your yearly property taxes, please contact your county assessor's office.

Aggressive vs. Conservative Qualification Estimate Lenders typically weigh a number of factors when deciding how much they are willing to lend you. One consideration is the ratio of your housing debt to income and your total debt to income. This calculator offers estimates based on both conservative and aggressive ratios.

Savings Rate Savings rate refers to the annual amount of interest you can earn on money you save. For many people, a savings account which earns 3.5% to 4.5% interest is an appropriate choice. This rate is generally used to compare two loan options. For example, if you decide to make a larger down payment on your home, you are sacrificing the interest you would have earned on the additional amount of money. The calculators take this "time value of money" into account.

Tax Rates In some home financing calculators, you are asked to make a comparison between two financing options. If one of the options costs more than another, the difference is invested into a savings account because you've saved money with that option. To make a fair comparison, the calculator tracks the balance and interest earnings on this account. As earnings in this account grow, they are taxed at the rate you indicated. Your personal tax rate is also used to compute your tax savings. To estimate your tax rate, divide the amount you paid in taxes last year by your income. If prompted, please include federal and state taxes.

Tax Savings If you itemize your tax return, you will probably be able to claim a deduction for the interest you have paid on your mortgage loans. A deduction is the amount you are allowed to subtract from your taxable income. It reduces the amount of your income on which you must pay taxes.When you report your income to the IRS, you are allowed to reduce the amount of income which will be taxed by either:

A predetermined amount called a Standard Deduction. Standard Deductions vary according to your marital status.
An itemized list of specific types of expenses you incurred called Itemized Deductions.

If the total of some of your expenses exceeds the applicable Standard Deduction amount, you would pay less taxes by itemizing these expenses on the IRS's Schedule A. Mortgage interest, property taxes, and discount points are usually expenses you can include on Schedule A.The amount you can deduct if you itemize your expenses can decrease if your adjusted gross income exceeds a certain amount. The results of these calculators should not be construed as tax advice and you should contact your tax advisor to determine your actual tax results. The calculator assumes that you have expenses greater than the Standard Deduction so that you itemize your expenses on Schedule A. The calculator also assumes that your expenses which are not related to mortgage interest and property taxes are at least the amount of your Standard Deduction. Therefore, you can reduce the amount of income for which you are taxed by the full amount you have paid for mortgage interest, property taxes and discount points.As an example, if you are single, the calculator assumes that you have itemized deductions for charitable contributions, state and local taxes and medical expenses (in excess of 7.5% of AGI) of at least $4,550. Here is an example:

Term The length of time that you will make payments on your loan. Typical mortgages have terms of 15, 20 or 30 years. NOTE: The accuracy of this calculator and its applicability to your circumstances is not guaranteed. You should obtain personal advice from qualified professionals

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