Debt Free

If you have an adjustable rate mortgage, you're probably well aware that it will adjust and your payments will go up. Unless you're a psychic, you probably don't know how much yet. Or, if you're like many homeowners, you may be unaware that you have an (adjustable rate mortgage) ARM, that it will go up, or why in the hell your mortgage payment would ever change.

First of all, check your mortgage documentation if you are unsure what type of mortgage you're committed to. Really, this is one piece of financial information you shouldn't be in the dark about. I'm not making this up about Americans not knowing. According to a survey (I've referenced it in previous posts) conducted by Gfk Roper, 34% of Americans actually don't have a clue about what type of mortgage they pay every month.

If you have an adjustable rate mortgage, there are some terms you should be familiar with. If you don't know what type of mortgage you have, you probably don't know what these mortgage terms mean, either, so read up.

Mortgage Term Definitions:

Index: By definition, ARMs adjust, You may not know how this all happens. There are various interest rates used in the financial community that are, for the most part, used by financial institutions for determining how much interest is charged for interbank lending. These are used as an index to base your ARM upon. As the index changes, so will the interest rate you pay for your mortgage. Every so often (exactly when is spelled out in the terms of your loan that you probably didn't read if you're unaware what type of mortgage you have) the appropriate index is used to calculate your mortgage interest rate. Some of the most popular indices are the 1 year treasury rate, COFI (Cost Of Funds Index), the LIBOR (London InterBank Offered Rate), and the MTA (Monthly Treasury Average).

Margin: This is a killer for ARMs. Margin is the number of percentage points the the lender adds to whatever index applies to your ARM when determining your interest rate. The total of the Index and the margin is the interest rate you'll be paying. The one thing not known by most consumers is what the margin their lender uses for this calculation. However, your lender is not required by law to disclose you ARM's margin in the loan disclosure documentation.

Cap: This is the maximum number of percentage points that your ARM can adjust. Even if the sum of the index and margin are greater than the cap, your mortgage can only adjust by number of percentage points allowed by the cap. There a various caps that will apply to your ARM. There is a periodic cap that determines how much your mortgage can adjust at each adjustment period. There is also a lifetime cap that states the maximum percentage your mortgage interest rate may be. Sadly for mortgage holders, the is also a floor cap that tells how much the lowest interest rate your lender will charge.

Teaser: Here's where so many mortgage holder's get into trouble. The teaser rate is an artificially low interest rate used in the initial period to keep the payment, well, artificially low. The thing is that too many mortgage holders rely on this dollar amount when determining how much home they can afford, only to find out they really can't afford their home after all. You usually aren't able to these artificially low payments for very long, only about a year in most cases, so your joy may be short lived.