 Understanding
a LIBOR ARM
|
 Dear
Dr. Don,
What is a 5/1 LIBOR ARM?
-- Silviu Selects
 Dear Silviu,
An adjustable-rate mortgage, or ARM, has a variable interest rate.
The interest rate on a LIBOR ARM varies with changes in the London
Inter-Bank Offered Rate, or LIBOR. Think of LIBOR as the British
equivalent of the fed funds rate.
There are different LIBOR rates, so you need to know
which LIBOR rate the mortgage is priced on. Bankrate tracks the
one-, three-, six- and 12-month LIBOR
rates on its Rate Watch pages.
A 5/1 ARM is a hybrid ARM, meaning it has both a fixed-rate
and variable-rate component. In the first five years of the mortgage,
the loan has a fixed interest rate. After five years, the interest
rate is reset at the pricing spread stipulated in the loan agreement.
Adjustable-rate mortgages can have rate caps and floors that limit
how the rate adjusts, either for a single change or in aggregate
over the term of the mortgage. It's important to know how the interest
rate on a mortgage loan can change based on the terms of the loan
agreement.
A 5/1 ARM gives you the certainty of a known interest
rate in the early years of the loan and normally carries a lower
interest rate than a 30-year fixed-rate mortgage because the borrower
is taking on interest rate risk after the first five years of the
loan.
As I write this, the Bankrate national average interest
rate on a 30-year, fixed-rate mortgage is 6.42 percent, while the
national average on a 5/1 ARM is 6.24 percent. If you only plan
on being in the house for about five years, using 5/1 ARM financing
gives you a lower interest rate with very little interest rate risk.
ARMs, even 5/1 ARMs, can be priced on a host of different
underlying interest rates. LIBOR is just one. Others include the
cost of funds index, or COFI; the cost of savings index, or COSI;
the Treasury bill rate; the constant maturity treasury, or CMT;
the monthly treasury average, or MTA, and the prime rate.
Bankrate has an interactive
work sheet that can help you decide if a hybrid ARM is right
for you. It won't advise you on which underlying index best fits
your needs, but you'll see if a 5/1 ARM is suggested as a preferred
choice in financing your home.
To ask a question of Dr. Don, go to the "Ask
the Experts" page and select one of these topics: "financing
a home," "saving & investing" or "money."
|
