Adjustable Rate Mortgages and the Eleventh District Cost of Funds
An adjustable rate mortgage, variable rate mortgage or floating rate mortgage is a mortgage where the interest rate on the note is periodically adjusted based on an index. This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate. This is not to be confused with the graduated payment mortgage, which offers changing payment amounts but a fixed interest rate.The 11th District Cost of Funds is one of the most commonly used adjustable rate mortgage indexes, because many lenders believe that an index that moves with their cost of funds reduces their risk. Adjustable rate mortgages are based on this index can adjust every month, every six months, or every year.
Some types of ARMs (for example, option ARM loans) offer payment caps rather than interest rate caps, which limit the amount the monthly payment can increase. If a loan has payment cap but has no periodic interest rate cap, then the loan may become negatively amortized: if the interest rates rise to the point that the monthly mortgage payment does not cover the interest due, any unpaid interest will get added to the loan balance, so the loan balance increases. However, you always have the option to pay the minimum monthly payment, or the fully amortized amount due.
In finance, negative amortizations occur when the borrower pays back less than the full amount of interest owed to the lender each month. The shorted amount is then added to the total amount owed to the lender. Such a practice would have to be agreed upon before shorting the payment so as to avoid default on payment.
There are advantages to the Cost of Funds Index. Flexibility in the monthly payment is one of the main advantages. With COFI-indexed ARMs you will usually have a choice of payment options. Besides fully indexed and minimum payment options your COFI ARM will probably have an interest only payment option and you will be able to change payment options every month if you like.
COFI ARMs may be used for tax planning. The borrower can defer interest payments and at the end of the year, analyze their tax situation. If it serves their tax interests, they can make a lump sum payment toward any interest that has been deferred and deduct it for tax purposes.
Whether or not this index is used, it is absolutely essential that a consumer knows their options and can interpret what is being done with their home and investment. Shopping for the right mortgage broker will mean the difference between and educating experience or expensive joyride.
