Adjusted Rate% = Index Rate% (at time of adjustment) + Your Margin%

For example, suppose you have a 5-year ARM with a margin of 2.25% (the most common for prime ARMs) and the adjustment index is the 1-year LIBOR (the most common index for prime ARMs).  Suppose at the time the loan adjusts the 1-year LIBOR rate is 5.25% (typical rate in 2006), your adjusted rate would be 7.5% (=5.25% + 2.25%).  On the other hand, if your rate adjusted on November 1, 2008, your adjusted rate would likely about 6.25%, since the index was about 4.00% in October which is the value that was likely used to determine your rate.  If your loan adjusted on January 1, 2009 you'd be luckier, since the index was 2.0% at the end of December, 2008, so your adjusted rate would be 4.25% for the next 12 months.  Since each loan has its own specific terms regarding the index value used to adjust the rate, consult your note language or your loan servicer.  The example demonstrates the importance of paying attention to the margin when you finance using an ARM (the lower the better).

Lenders also refer to the "fully-indexed rate," which is the value of a margin plus the index at any moment in time:

   Fully-Indexed Rate% = Index Rate% (at any time) + Your Margin%

In years past you could expect the market rate for a newly issued ARM to be close to the fully-indexed rate, with allowance for whether the fixed rate period was 1-year, 2-years, 3-years, 5-years, 7-years or 10-years.  That hasn't been the case very often since Fall, 2007.  Due to the financial crisis there have been several periods when the rate for a new ARM has been very much higher than the fully-indexed rate.  In fact, during November, 2008 ARM rates were extremely high compared to U.S. Treasury rates that were near historically low levels.  Furthermore, there has been much greater variation in rates for the same loan between two different lenders than any time in the past, so rate shopping is very important right now.  At the present time, it probably isn't a good idea to refinance an ARM into another ARM, since the fully-indexed rate is likely to be significantly lower than the fixed rate on a new ARM.  Interestingly, as of January 2, 2009, the typical wholesale par rate (before pricing adjustments for your particular parameters) for a 30-year fixed rate conventional loan is about 5.00%, about the same as the best rate available for a 5-year ARM, but about 0.75% higher than the fully indexed rate on a typical prime ARM having a margin of 2.25% and using the 1-year LIBOR index.

If you have an ARM that will adjust soon, you might periodically check the fully-indexed rate and the trend in your index rate to get an idea of what might happen to your rate at the time of your next adjustment.  To aid in that, you could check your index rate on any number of websites.  One of our favorite places to look is the ARM index page at the Mortgage-X website at http://www.mortgage-x.com/general/mortgage_indexes.asp.  It has very complete information about all the indexes used for all ARMs. -END-