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January 19, 2004
ARMs are complicated instruments. No one
characteristic fully describes one. This is why, when readers ask me for the
pros and cons of COFI ARMs, or Libor ARMs, or flexible payment ARMs, I get
heartburn. You can�t assess an ARM based on only one of its features.
But some features are more important than
others. If any one feature deserves to be considered the "real price"
of an ARM, it is the fully indexed rate, or FIR. Yet ironically, I have never
had a reader ask me a question about the FIR.
The FIR is the
most recent value of the interest rate index used by the ARM (such as COFI or
1-month Libor) at the time the loan is taken out, plus a margin. The margin is
the lender�s spread over the index, often 2.5% to 3%, but it can vary widely.
On December 20, 2003, when this was written, the
most recent value of the COFI index was 1.821% for the month of November. If an
ARM using COFI had a margin of 3 %, its FIR would be 4.821%.
The importance of the FIR is that it indicates
where the ARM rate may go when the initial rate period ends. If the rate index
does not change, the FIR will become the ARM rate, subject to any caps that may
limit a rate change. Ignoring the FIR is deception by omission.
Just how deceptive this omission can be is well
illustrated by an advertisement for a "1.95% ARM", which I found in my
email this morning. What the ad does not say is that the 1.95% rate holds for
just one month. If I closed on this loan today, and if it used the COFI index
with a 3% margin, my rate in January would be 1.95%, and in February it would
jump to 3% plus the index value in December.
In other words, the ad told me the rate for one
month, but it did not give me any information bearing on what the rate might be
over the subsequent 29 years and 11 months. If you went to the lender�s web
site, you would not find the FIR. It is not a required disclosure and does not
appear on any documents.
Neither is the FIR mentioned by loan officers.
If they can help it, loan officers don�t discuss numbers that invite
comparison with those of other lenders. They are in the business of selling
ARMs, which they do by focusing on one sexy feature, such as a low initial rate
and payment, a stable index, or payment options.
This is why I continually receive letters asking
about these features, but I have never had a letter asking me about the FIR.
Loan officers may not even know the most recent value of the index, although
they will know the margin.
The importance of the FIR to the borrower
depends mainly on the length of the initial rate period. With a monthly ARM, it
is critically important, as already noted. With an ARM on which the initial rate
holds for 10 years, the FIR may mean little. With other ARMs, the importance of
the FIR will depend on the likelihood that the borrower will be in the house
past the expiration of the initial rate period.
If the FIR is important to you, reconcile
yourself to the fact that the system is rigged against you and you are going to
have to dig it out for yourself. The loan officer will give you the margin if
you ask, and will usually be able to identify the rate index. You are fine if he
says COFI, MTA, CODI, or Prime Rate because these are all unique series. Don�t
accept "Treasury" or "Libor" because there are multiple
indexes under each of these headings, and you need to know the one that applies.
When you have identified the rate index, you can
find the latest value on the internet. Go to ARM
Indexes where you will find a list of all the indexes, and the web sites at
which the latest values can be found.
Copyright Jack Guttentag 2004
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