While financial jargon like CMT-indexed ARMs can be a bit overwhelming at first, all that it takes is a little bit of research to understand the various concepts.
So in this article, we discuss Adjustable-Rate Mortgages, also called “Variable-Rate Mortgages” and “Floating-Rate Mortgages,” and why you should know more about Constant Maturity Treasuries.
What is an Adjustable-Rate Mortgage?
In short, an Adjustable-Rate Mortgage (ARM) is a loan that offers borrowers a short introductory period with a low, fixed interest rate (teaser rate).
After this introductory period, generally two to five years, the rate on the loan becomes adjustable.
While there certainly are benefits to Adjustable-Rate Mortgages, there are also drawbacks and risks.
- Your interest rate and payment will adjust up and/or down over the course of the loan.
- Your interest rate can potentially increase to the lifetime cap at some point during the term of the loan.
- Many ARMs have a prepayment penalty. So, you’ll be penalized for paying your loan back in full before the agreed upon schedule.
Related: Adjustable Rate Mortgage (ARM)
Types of Adjustable-Rate Mortgages
“Adjustable-Rate Mortgage” is an umbrella term that comprises different types of mortgages. Three common types of ARMs are:
- Constant Maturity Treasury (CMT). CMT indexes represent the yield of various Treasury securities. Since a CMT index is linked to Treasuries, which are essentially risk-free, lenders charge a risk premium in the form of a higher interest rate.
- Cost of Funds Index (COFI). COFI is the weighted-average interest rate paid by the 11th Federal Home Loan Bank District savings institutions for savings. The index usually lags the market in both up and down markets, making it very stable. Lenders add a specific number of percentage points (called a margin) to the index to set the interest rate borrowers pay.
- London Interbank Offered Rate (LIBOR). LIBOR is the most widely-used benchmark for short-term interest rates and is the primary indicator for the average rate at which banks can obtain short-term loans in the London interbank market.
Benefits of a CMT-Indexed ARM
CMTs are the most popular type of Adjustable Rate Mortgage, with the 1-Year Constant Maturity Treasury index (1 Yr CMT) used for about half of all ARMs.
CMTs present the most benefit to borrowers with the least amount of risk, allowing borrowers to secure home financing at initial rates that are often below those of fixed-rate mortgages.
In addition, CMT-indexed ARMs benefits include:
- Lower initial rates and monthly payments.
- Financial savings for borrowers who only plan to stay in their home for a short period of time.
Related: Mortgage Teaser Rates
Marimark Mortgage
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