The intrest rates for ARMs are tied to one of many well-known economic measures that can't be incluenced by the lender. Some examples of these are: Six Month T-bills: usually the most volitile of indicies and most closely reflects current market conditions. The rate is established at weekly auctions. One Year T-bills: volitle. This rate is based on the weekly average of daily yields of actively traded 1-year T-bills. Three to Five Year T-notes: similarly volitle. These are based on constant maturities. Cost of Funds Index: stable. Compiled by the Federal Home Loan Bank Board and gives the average interest rate that member banks and Savings and Loan associations paid on funds during the previous period (reported monthly by district) The most commonly used Cost of Funds index is the 11th district. Average Cost of Mortgage Rate: fairly stable. This index consists of the average interest rate charged by major lenders for newly originated fixed and adjustable rate conventional mortgage loans on previously occupied homes. Published monthly. Probably the most accurate assessment of changes in mortgage interest rages. Libor Rate: stable. London Interbank Offered Rate: One of the most stable during most periods although recently instability in the lending markets have led it to become volitle. If the margin is not unreasonable this might be one of the best to use. Read at the index history that the lender offers you (required by law) and look at the volitle interest rate period of 1978-1982 and the 1990's. Those years will tell you more than most others about what this index is likely to do when interest rates change dramatically.
The lender picks the index, so shop for a lender who uses a stable index. Also look for a lender who gives you the longest teaser rate possible.
A “margin” is added to the index to determine the actual mortgage interest rate. (3% margin + 4% interest rate = 7% effective mortgage interest rate)
The margin is tied directly to the index used. If the index is generally low, the lender will tend to use a higher margin to compensate. Higher index, lower margin.