mortgage

Adjustable-rate mortgage indexes explained

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 the overall market. The COFI's slow, lagging pace benefits borrowers when 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 one-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 loan program, the monthly payment might be adjusted every month or once a year.

Rates indexed to the last 12 monthly averages for one-year Treasuries move slowly. "If interest rates were to go up 100 basis points tomorrow," says Goldstone -- in other words, if they rose 1 percentage point -- "that index would go up only one-twelfth of 1 percent the next month. And then the second twelfth the next month, and so on."

The 12 MAT index reacts slowly to fluctuations in short-term rates and smoothes them out.

London Interbank Offered Rate, or 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. Typically, a one-month LIBOR will be based on the rate for a one-month loan between London banks, and a mortgage based on the one-month LIBOR would be adjusted every month. A six-month LIBOR would be based on the rate for a six-month loan between London banks, and the mortgage based on that rate would be adjusted every six months.

"It is an index that has wider coverage and wider sensitivity to the world, rather than just the domestic market," says Anthony Hsieh, CEO of HomeLoanCenter.com. 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.

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