Inside an Adjustable Florida Home Mortgage Loan: Indexes Explained

Those with adjustable Florida home loans have been considering refinancing at a higher pace recently. As interest rates have increased, the desire to lock in monthly payments has gone along with them.

Neverthless, almost one-third of buyers these days are signing up for adjustable rate mortgages (ARMs). If you’re included in this group, it’s time to familiarize yourself with the most confusing element of an ARM: the index.

Analyzing an adjustable rate Florida home loan

When you get an ARM, two main factors determine the rate you pay: the index and the margin. The index is a rate set by market forces and published by a neutral third party. The margin is an agreed-upon number of percentage points that is added to the index to determine your Florida home loan rate.

A thorough mortgage shopper will run across a bunch of acronyms to denote various ARM indexes. Each index responds at its own peculiar pace to the economy’s ups and downs. These include:

• COFI
• LIBOR
• MAT
• CMT

Such indexes can be divided into two broad categories: those based upon rate averages and those based upon more volatile spot rates. Larry Goldstone, president of Thornburg Mortgage, a portfolio lender that does only ARMs, says that ARMs based on averages tend to have higher margins than ARMs based on spot rates.

Someone who gets an ARM indexed to rate averages “gets one benefit and one drawback,” Goldstone says. “The benefit is that, in a changing rate environment, an average index will move more slowly, so the payment changes more slowly. The drawback is that the margin typically is higher, and so the rate you pay is higher.”

“If a consumer is looking at different ARMs with different index options, it’s a good idea to look at different graphs,” says Garrett Brief, vice president for product development for mortgage lender IndyMac Bank. Graphs of each Florida home loan type’s fluctuations will help you understand how rapidly and how much the rates change.

Let’s take a look at some of the popular types of adjustable rate Florida home loans, how they work and who they are suited for:

11th District Cost of Funds Index (COFI) index: Rates on COFI-indexed mortgages move up and down slowly. With most COFI-based Florida home loans, the rate is adjusted every month and the monthly payment is adjusted once a year. This means that some borrowers can end up owing more than they borrowed if their payments don’t cover all the interest due, a phenomenon called “negative amortization.”

Anyone who has had a savings, money market or interest-bearing savings account knows that those rates are low and move tortoise-like. The COFI (pronounced “coffee”) is calculated at the end of every month for the previous month, so it lags behind the overall market. The COFI’s slow, lagging pace benefits borrowers when Florida home loan rates are rising, but not when rates are falling.

12-month Treasury average (MTA or MAT) indexes: Rates on ARMS indexed to the 12-month average of the one-year Treasury bill are usually called the “12 MAT” or “12 MTA.” Every month, the U.S. Treasury calculates and publishes the average yield on a constant-maturity 1-year Treasury bill for the previous month. The 12 MAT index takes the average of the last 12 averages.

Like the COFI, the rate on a 12 MAT is adjusted every month. Depending on the Florida home loan program, the monthly payment might be adjusted every month or once a year. Rates indexed to the last 12 monthly averages for 1-year Treasuries move slowly.

The 12 MAT index reacts slowly to fluctuations in short-term rates and smoothes them out.
London Interbank Offered Rate (LIBOR) indexes: The LIBOR (pronounced LIE-bore) tracks the rates at which London banks pay to borrow one another’s reserves. It fluctuates more rapidly than the COFI or 12 MAT. The LIBOR is sort of a rough equivalent of the federal funds rate in the United States, but it is set by the market, not a government entity.

There are various LIBOR maturities. The most common are one-month, six-month and 12-month. “It is an index that has wider coverage and wider sensitivity to the world, rather than just the domestic market,” says Anthony Hsieh, president of HomeLoanCenter.com.

Florida home loan lenders like the LIBOR because it “is very sensitive to both up and down markets, on the rise and the decrease,” Hsieh says. The borrower shares the risk with the lender.

Constant-maturity Treasury (CMT) indexes: These indexes follow the weekly or monthly fluctuations in the yields for 1-year Treasury bills. The rates on CMT-indexed ARMs move up and down rather quickly. Most CMT-indexed mortgages are adjusted once a year.

CMT-indexed Florida home loans are among the most popular ARMs. Hybrid ARMs - home loans that have a fixed rate for the first few years, then adjust annually - usually turn into CMT-indexed mortgages when they enter their adjustment periods.

Reaching a Florida home loan conclusion

Mortgage bankers say that it’s important that a borrower understand ARM indexes. But there are other things to consider: the margin, the caps on how high the rate can go, and other features.

“The more important thing is the flexibility of the loan program,” says Vijay Lala, vice president of product development for Countrywide Home Loans.

Some Floria home loan programs give you three or four choices for each month’s payment: You might have the option of making a “minimum payment” that might not even cover the interest accrued in the last month (the aforementioned negative amortization), an interest-only payment, a fully amortizing payment or a full payment plus some extra to be applied to principal.

Other features to look for include the ability of a home’s future buyer to assume the mortgage, and the capability to modify the Florida home loan - to switch to another index without having to go through an expensive refinance.