When you consider an adjustable-rate mortgage (ARM), the margin may be the most important component. Regardless of the deeply discounted "start rate" you might enjoy, the margin specified in your ARM dictates the size of future interest rate adjustments. You want an ARM with the lowest possible margin for which you qualify, based on your credit report. The margin identifies the percentage rate above the index rate on your ARM.
Mortgage Loan Margin Defined
The margin on a mortgage loan is the percentage added after your lender examines your index 45 to 60 days prior to a scheduled interest rate adjustment specified in your loan note. Margins vary based on the mortgage loan product and your credit score. A margin of 2 percent is much better than a margin of 6 percent. Interest rates can fluctuate up or down based on current market conditions, but smaller margins are always beneficial to you, regardless of the state of the U.S. economy.
ARMs are tied to an index that is published and outside of lender control. Popular mortgage indexes include the U.S. Treasury Bill, LIBOR (London Interbank Offered Rate), and COFI (Cost of Funds Index), all of which are published daily in the Wall Street Journal. These indexes are used because they are indicative of the world's current rate structure, consistently analyzed and published, and reasonable. They serve as the "base rate" for your ARM.
Margin and Index Calculations
You don't need a master's degree in statistics to calculate ARM interest rates. Simply take the index and add the margin to arrive at your new interest rate. For example, say your index is the LIBOR at 2.5 percent. and your margin is 4 percent. Your new rate will be 6.5 percent -- 2.5 plus 4 percent. As you can see, a margin less or more than 4 will benefit or displease you when your upcoming mortgage payment is calculated.
Lenders use margins to adjust interest rates on ARMs to compensate for less than superior credit reports. Newer homeowners sometimes overlook margins, being captivated by low start -- and qualifying -- rates. But start rates, however enticing, only last for the initial period of an ARM -- typically one to two years -- with 27 to 30 years to come over the life of your mortgage. Don't be afraid to try to negotiate your margin with your mortgage lender before you sign your loan note. You might save thousands by doing so.
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