Loan Questions - Interest Only Loans, LIBOR Loans, Mortgages and more

London Inter Bank Offering Rate (LIBOR) is an average of the interest rate on dollar-denominated deposits, also known as Eurodollars, traded between banks in London. The Eurodollar market is a major component of the International financial market. London is the center of the Euromarket in terms of volume. The LIBOR is an international index which follows the world economic condition. It allows international investors to match their cost of lending to their cost of funds. There are several different LIBOR rates widely used as ARM indexes: 1-, 3-, 6- Month, and 1-Year LIBOR. The 6-Month LIBOR is the most common.

“Interest Only” Adjustable Rate Mortgages (ARMs) have become extremely popular and effective tools for helping prospective homebuyers achieve their dream of homeownership, it also allows for current homeowners to drastically reduce their monthy payments.“Interest Only” ARMs can be an excellent choice of financing under certain conditions, such as rising income expectations, high interest rates, and short-term homeownership. Below are the four items that are normally associated with each arm products.

• Initial interest rate, which is typically one to three percentage points lower than that of most fixed rate mortgages. Lower interest rates and the popularity of the “Interest Only” option make ARM’s easier to qualify for consumers. The initial interest rate is tied to certain economic indicators that dictate in part what the monthly payments will be.

• Adjustment interval, at the time between changes in the interest rate and/or monthly payment will be.

• Index, against which lenders measure the difference between what they are making on their investment in the mortgage and what they could be making on other types of investments. The most popular index has been the one- year Treasury bill (also called T-bill). The Libor index is becoming more popular as the margin on most of these products are lower than most T-bill ARM’s

• Margin, this is what the lender adds to the index to establish the adjusted interest rate on an ARM. The margin is usually 1.75 to 2.00 percent on the Libor and 2.25 to 2.75 percent on the T-bill. Keep in mind the margin is the most important aspect of short term Interest Only ARM’s like the 1 month and 6 month Libor products. ARM’s usually contains certain consumer safeguards such as caps, which limit the amount that the interest rate can go up or down within the adjustment period. For instance, a typical ARM would have a 1st adjustment cap of two percentage points and a lifetime cap of normally 5 to 6 percent over the start rate. This means that a loan with an initial interest rate of 4.75% for the 1st 5 years would be able to go no higher than 9.75 percent over the life of the loan with a 5% lifetime cap. Most short term Libor ARM’s like the 1 month and 6 month do not period caps but do have lifetime caps, these caps vary from lender to lender.

Other options you should ask about when shopping for an ARM are:

• Assumability, or whether you may transfer the mortgage to a new homebuyer, usually with the same terms if the new homebuyer qualifies for the loan. ARMs are almost always assumable.

• Convertibility allows the borrower to change an ARM to a fixed rate mortgage, usually at the end of some predetermined period, locking in a lower interest rate.

Q. WHAT IS THE MTA INDEX? ( Top )

A. The Monthly Treasury Average is a relatively new ARM index. This index is the 12 month average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. It is calculated by averaging the previous 12 monthly values of the 1-Year CMT. Because this index is an annual average, it is more steady than the 1-Year CMT index. The MTA index generally fluctuates slightly more than the 11th District COFI, although its movements track each other very closely. This index is normally used with "Option ARM" products that allow for consumers to make four different payment options.

MTA INDEX FROM JANUARY 02 THRU PRESENT
	2002	2003	2004	2005	2006	2007
Jan	3.260	1.935	1.234	2.022	3.751	4.983
Feb	3.056	1.858	1.229	2.171	3.888	5.014
Mar	2.912	1.747	1.225	2.347	4.010	5.027
Apr	2.787	1.646	1.238	2.504	4.143	5.029
May	2.668	1.548	1.288	2.633	4.282	5.022
Jun	2.553	1.449	1.381	2.737	4.432	5.005
Jul	2.414	1.379	1.463	2.865	4.583	4.983
Aug	2.272	1.342	1.522	3.019	4.664	4.933
Sep	2.180	1.302	1.595	3.163	4.758	4.863
Oct	2.123	1.268	1.677	3.326	4.827	4.788
Nov	2.066	1.256	1.773	3.478	4.883
Dec	2.022	1.244	1.887	3.613	4.933

Q. HOW DOES THE TREASURY INDEX WORK? ( Top )

A. These indexes are based on the results of auctions that the U.S. Treasury holds for its Treasury bills, notes and bonds. Treasury bills are issued by the U.S. government with maturities of 3, 6 months, and 1 year in order to pay for the national debt and other expenses. ARMs tied to the 3-, 6-Mo, and 1Yr T-Bills usually adjust once every six months, once each year, or once every three years accordingly. The 1 year Treasury Bill index (1-year T-Bill) is the most commonly used index for traditional ARM products that amortize. It is also become widely used with longer term "Interest Only" ARM products like the 3,5,7 & 10/1 ARM's.


Q. WHAT IS THE COFI INDEX? ( Top )

A .What is the 11th District Cost of Funds Index? The Federal Home Loan Bank (FHLB) System is comprised of 12 Districts, each of which has its own District Bank-The 11th District is based in San Francisco and includes member savings institutions from Arizona, California and Nevada. The 11th District COFI was introduced in 1981 and represents the weighted average cost of all funds for savings institutions eligible to be members of the 11th District. The source of these funds includes savings and checking accounts, money market accounts, short term CD accounts, advances by the FHLB District Bank, and other borrowed money. The latest statistics released by the Federal Home Loan Bank Board (FHLBB) show the following approximations:

- 60% of deposits are in Checking and Savings accounts
- 30% of deposits are in the 6 month and 1 year CDs
- 10% of deposits are in 2 to 5 year CDs

The index represents a weighted average cost of funds and includes long-term accounts-The 11th District COFI is popular with both thrift lenders and borrowers because the index adjusts slowly and stays consistent with those lenders' costs.

Q. What is the CODI Index? ( Top )

A. CODI - Certificate of Deposit Index. A CODI loan is based on one of the most stable indexes currently available. Simply put, it is the aggregate sum of what banks are paying to their depositors on their 3-month CD accounts! As we all know, these short-term CDs generally offer a very low rate of return. Currently, the average rate paid by a bank on a 3-month CD is approximately 1.40%. The overall index is calculated by using an average, of an average, of an average. It works this way: they take the daily average of these 3-month CDs and add those daily values together for one month. They then divide that sum by the number of days in the month to reach a monthly value. Next, they add that current monthly value to the previous 11 monthly values and divide by 12 to give us the current CODI Index.

CODI - Certificate of Deposit Index

Q. What is the COSI Index? ( Top )

A. COSI - cost of savings index. This Lender borrows money from consumers in the form of deposits, i.e. C/D's, checking and savings accounts, and then lends the money out as home mortgages. Then they place a fixed "Margin" on top of their own Index. The interest rates in effect on these deposits are the basis for the COSI. The COSI is not based on actual interest paid on deposit accounts, but rather on a weighted annualized rate of all interest rates in effect on deposit accounts as of the last day of each month.

Q. How do I calculate my debt ratios? ( Top )

A. Besides credit considerations, lenders review the capacity of the borrowers to repay the mortgage obligation. Lenders calculate the debt ratio dividing the total monthly debts, this is your total monthly housing expense including taxes and insurance for the proposed loan plus the borrowers other monthly credit obligations) by the total monthly income. For example, if the borrower had a total income of $7,000 per month and total payments of $2,700 per month ($2,000 for housing expenses and $700 for other credit obligations), the debt ratio would be ($2,700 divided $7,000 = 38.5%). 40 to 45% is the norm for total income to debt ratios.

Some lenders will allow up to 50% total dept to income ratios, however they vary depending on the “Interest Only” loan program you choose and the lender.


Q. What is loan to value ratio? ( Top )

A. Loan-to-Value Ratio, or LTV as it is commonly referred to, is the ratio of loan amount to the appraised value (or the sales price, whichever is less) of a property. For example, a loan of $700,000 on a property valued at $1,00,000 is a 70% LTV . Lenders have become highly aggressive when it comes to LTV requirements. Some will allow up to 100% LTV. The higher the LTV though the more stringent the lenders become on credit and debt ratio.


Q. WHAT KIND OF PROPERTIES ARE ELIGIBLE FOR “INTEREST ONLY” LOANS? ( Top )

A. Most "Interest Only" loan programs are eligible for the main property types listed below.

· Single Family Attached
· Eligible Condos - Low Rise and High Rise
· Eligible PUD Units
· 2-4 Units Note:

Co-Ops and Mixed Use Properties are available for financing but there are limitations on these types of properties. Contact a mortgage professional for more information on what these limitations are. but always make sure you explain the property type at the time of application (or before) to save any future delays in processing your application.


Q. WHICH LENDER SHOULD I USE FOR AN “INTEREST ONLY” LOAN? ( Top )

A. Comparing loans of different lenders is often the most difficult part of shopping for a home loan. It is important to keep in mind that mortgage packages consist of more than interest rates. They consist of a quoted rate, points and closing costs.

Most lenders we researched and that will contact you do not charge application fees, origination fees and points however as noted many times throughout our website these items do vary from lender to lender so its important that when you are contacted by a mortgage professional to ask these questions up front. We usually suggest you consider a lender that does not have these fees, as they are normally the most competitive in the industry. There are however lock in fees that are sometimes charged to secure a given rate, this fee is normally credited back to you at closing of the transaction.

You may want to ask your mortgage professional if it make sense to pay points. Points are charged to lower the rate on the loan. Most lenders will allow you to choose amongst a variety of rate and point combinations for the same loan product. Therefore, when comparing rates of different lenders, make sure you compare also the associated points. It has been our experience from talking to various lenders that it usually does not make sense to pay points on an “Interest Only” ARM product as the periods are normally shorter, it could make sense however on a longer term fixed rate loan, it comes down to how long you think you will be in your home.

Closing costs typically consist of loan related fees that you will find in section 800 of the good faith estimate. (i.e. the fees which lenders charge to process, underwrite , approve & fund the mortgage.

When comparing loans of different lenders you need to thoroughly compare all loan features: maximum LTV, credit and cash reserve requirements, qualifying ratios, etc. Be sure to ask if the loan has a prepayment penalty.

One thing that normally will affect the quoted interest rate is the lock-in period, during which the interest rate and points quoted to you will be guaranteed. Lock-ins of 30, 45 and 60 days are common. Usually a longer lock-in period will have higher rate. The lock-in period should be long enough to allow for settlement before lock-in expires.


Q. What is the best way to compare loans among different lenders? ( Top )

You will want to compare loan products of the same type among different lenders:

1. Get the same quote for a specific loan product like a 5/1 ARM “Interest Only” for a specified period of time, a reasonable time frame for refinance is 30 days, on a purchase it would be the amount of days until you actually close. You have to compare different lenders on the same product and rate lock-in periods. Most lenders can offer you a variety of rate and point combinations for the same loan product and allow you to choose the lock-in period.

2. Add up the total lender fees for that rate inclulding points and loan related fees. There are a number of different fees paid in connection with a loan, some lenders have different names for them. You should ask for a good faith estimate in writing so you can see what the real lender charges are.

These fees can include processing, underwriting, appraisal, the cost of a credit report, tax service fee, application, commitment, wire transfer fee, etc. Be sure as stated before to ask if they have an upfront application fee, and if so is this credited back at closing.
Remember all lenders are not created equal so be sure to compare and get it in writing.

Q WHAT IS APR? ( Top )

The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. It is designed to represent the true cost of the loan to the borrower, expressed in the form of a yearly rate. The purpose is to prevent lenders from hiding fees and upfront costs behind low advertised interest rates. However the APR is in fact a very confusing number. Even lenders admit it is confusing since it includes some, but not all, of the various fees and insurance premiums that accompany a mortgage. The rules for calculation of this number have not been clearly defined, so APRs vary from lender to lender and from loan to loan, depending on which types of fees and charges are included.

We do not recommend relying upon the APR as an indicator of a loan product's value. The APR calculation is based upon the assumption that you keep your loan for the entire period of the loan, say 30 years, which in reality may not be the true hold period for a borrower.

In addition, the APR model is flawed in that when a product is variable and tied to an index, the index is assumed to never change. This obviously is an invalid assumption that can lead again to a number, which in fact can not be compared, from one quoting source to another.

Finally, the APR won't tell you anything about balloon payments and prepayment penalties and how long your rate is locked for. So a loan with a lower APR is not necessarily a better loan.