Description of Connecticut Adjustable Rate Mortgages (ARMs)
Connecticut adjustable rate mortgages, better known as “ARMs”, refer primarily to hybrid home loans which exhibit features of a fixed rate mortgage for a limited period of time and then are variable in subsequent years (true adjustable rate mortgages which adjust annually or even shorter are much less commonplace). The interest rate and monthly mortgage payment for adjustable rate mortgages is fixed for a set number of years (typically 3, 5, 7 or 10 years) and then adjust annually thereafter according to an index and margin.
The index for Connecticut adjustable rate mortgages is the variable portion of the interest rate used to calculate the fully indexed rate. Indexes for adjustable rate mortgages are widely published short-term interest rates usually 1 year in duration. The most commonly used indexes are LIBOR (London Interbank Offer Rate) and CMT (Constant Maturity Treasury Index – better known as the 1-Year Treasury Bill).
The margin is the fixed interest rate add-on to the index. The margin can vary lender-to-lender, but typically is 2.250% for ARMs based on LIBOR and 2.750% for Connecticut adjustable rate mortgages based on the CMT index.
The rate calculated by adding the index and margin together is known as the fully indexed rate of a Connecticut adjustable rate mortgage. For example, consider a 3/1 CMT ARM with an initial fixed rate of 4.250% that now is up for adjustment. If the 1-Year T-Bill rate was 2.164%, the fully indexed rate for the next year would be 5.000% (CMT index of 2.164% + 2.750% margin = 4.914% which is rounded to the nearest 1/8th or 5.000%).
Lenders limit (“cap”) the amount that the interest rate can adjust for Connecticut adjustable rate mortgages. The typical CAPS for the most common ARMS are as follows :
- 3-year ARM – 2/2/6
- 5, 7 and 10-year ARM – 5/2/5
The first number of the CAPS refers to the maximum adjustment that the rate can adjust at the first adjustment for a Connecticut adjustable rate mortgage. The second number of the CAPS is the maximum adjustment that the fully indexed rate can adjust in each subsequent year. Finally, the last number refers the maximum adjustment that the initial fixed rate can adjust over the life of the loan.
For example, consider a 5/1 ARM with an initial fixed rate of 4.750%. The maximum that the rate could change at its first adjustment after the initial fixed rate period of 5 years is 5.000% (5/2/5). This means that the rate for this Connecticut adjustable rate mortgage could theoretically adjust all the way to 9.750%. Instead though, let’s assume that the interest rate adjusted to 6.125% based on the current index plus the margin.
Every year thereafter, the rate for a Connecticut adjustable rate mortgage adjusts again according to the current index and margin. For a 5/1 ARM, the CAP for all subsequent years after the first adjustment is 2.000% (5/2/5). Assuming in our example that rate is now 4.875%, the maximum that the rate can increase is 6.875%.
The maximum that the rate can ever adjust no matter what is calculated with the index and margin is limited to 5.000% (5/2/5) over the initial fixed rate. In the example above, the initial fixed rate for the first 5 years was 4.875% which means that the rate can never adjust higher than 9.875% for this Connecticut adjustable rate mortgage.
It is important to note that not only can the interest rate increase on Connecticut adjustable rate mortgages, it can also decrease according to the index and margin. Similar to an increase, any drop in the interest rate is limited by the CAPS. However the decrease is limited by a floor which typically is set at the initial fixed rate.
Learn more about the different types of Connecticut adjustable rate mortgages including a Connecticut 1 year ARM, Connecticut 3 year ARM, Connecticut 5 year ARM, Connecticut 7 year ARM and Connecticut 10 year ARM.
Advantages of Connecticut Adjustable Rate Mortgages
- Lower interest rate and monthly payment than Connecticut fixed rate home loans
- Adjusted rate during periods of low short-term interest rates is much lower than other types of mortgages
Disadvantages of Connecticut Adjustable Rate Mortgages
- Interest rate is fixed for only a limited time and then adjusts every year
- Monthly mortgage payment can increase significantly once ARM adjusts
Borrowers Best Suited for Connecticut Adjustable Rate Mortgages
- Aggressive risk tolerance
- Intend to live in home for only a few years (7 years or less)
- Income expected to increase significantly
Borrowers Least Suited for Connecticut Adjustable Rate Mortgages
- Conservative risk tolerance
- Intend to live in home for a long time (7+ years)
- Will not be able to afford a higher mortgage payment, perhaps even significantly higher