Mortgage Indexes Explained

Treasury Bill (T-Bill) indexes
 
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 6-Month Treasury Bill index (6-MoT-Bill) is the most often used.
 
The Treasury Bill indexes move with the market and respond quickly to economic changes like the CMT indexes. The following graph reflects the movement of the 3-, and 6-Month Treasury Bills and compares them with the 1-Year CMT index.
 
The Treasury Bill indexes are reported by the Federal Reserve Board.
 
Note: The index commonly called the "1-Year T-Bill" is not a Treasury Bill; it's the 1-Year CMT index. It's important to know the precise name of the index; the names may sound alike, but there is a considerable difference between different indexes. Most 1-Year ARMs are tied to the CMT index, the "true" 1-Year Treasury Bill index are rarely used.
 
Constant Maturity Treasury (CMT) indexes
 
These indexes are the weekly or monthly average yields on U.S. Treasury securities adjusted to constant maturities. Yields on Treasury securities at "constant maturity" are interpolated by the U.S. Treasury from the daily yield curve, which is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market.
 
The CMT indexes are volatile and move with the market. They reflect the state of the economy, and respond quickly to economic changes. These indexes react more slowly than the CD index, but more quickly than the COF index or the MTA index (see historical graph below).
 
The following CMT indexes are the most often used for ARMs:
 
1-Year Constant Maturity Treasury index (1 Yr CMT)

This is the most widely used index. Roughly half of all ARMs are based on this index. It's used on ARMs with annual rate adjustments. It is also referred to as the 1-Year Treasury Bill (1Yr T-Bill) [see note], the 1-Year Treasury Security (1Yr T-Sec), or the 1-Year Treasury Spot index.
 
3-Year Constant Maturity Treasury index (3 Yr CMT)

This index is less popular than the 1-Year CMT. ARMs based on the 3 Year CMT will adjust every three years (3 Year ARMs).
 
It may be referred to as the 3-Year Treasury Security (3Yr T-Sec) index.
 
5-Year Constant Maturity Treasury index (5 Yr CMT)

Same as the 3 Year CMT, only ARM loans indexed to the 5 Year CMT will adjust once every five years. [The ARM's adjustment period is usually the same as the security's constant maturity.]
 
The CMT indexes are reported by the Federal Reserve Board.
 
Note: The CMT indexes have both weekly and monthly values. If your ARM is tied to a CMT index, be sure to note whether it's weekly or monthly.
 
London Inter Bank Offering Rates (LIBOR)
 
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. The LIBOR compares most closely to the 1-Year CMT index and is more open to quick and wide fluctuations than the COFI rate, as shown on our graph.
 
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.
 
LIBOR-indexed ARMs offer borrowers aggressive initial rates (lower than many other ARMs) and has proved to be competitive with such popular ARM indexes as the 11th District Cost of Funds, the 6-Month Treasury bill, and the 6-Month Certificate of Deposit. With the LIBOR ARMs borrowers are generally protected from wide fluctuations in interest rates by periodic and lifetime interest rate caps. LIBOR ARMs usually do not have negative amortization.
 
11th District Cost of Funds Index (COFI)
 
This index reflects the weighted-average interest rate paid by 11th Federal Home Loan Bank District savings institutions for savings and checking accounts, advances from the FHLB, and other sources of funds. The 11th District represents the savings institutions (savings & loan associations and savings banks) headquartered in Arizona, California and Nevada.
 
Since the largest part of the Cost Of Funds index is interest paid on savings accounts, this index lags market interest rates in both uptrend and downtrend movements. As a result, ARMs tied to this index rise (and fall) more slowly than rates in general, which is good for you if rates are rising but not good for you if rates are falling.
 
It should be noted that although COFI generally follows trends in market rates, it can move in an opposite direction over the near term (these periods are marked in white on the historical graph above).
 
The 11th District Cost Of Funds Index is the slowest moving and most stable of all ARM indexes. It smoothes out a lot of the volatility of the market. Since its initial publication (in 1981) the annualized volatility of COFI has been only 6.2% compared with more than 20% for the 1-Year CMT index during the same period.
 
The 11th District Cost of Funds index is one of the most popular ARM indexes. This index is primarily used for ARMs with monthly interest rate adjustments. Because this index generally reacts slowly in fluctuating markets, adjustments in your ARM interest rate will lag behind another market indicators. Many lenders believe COFI-indexed ARMs are some of the best deals available on the market today.
 
The COFI is one of the most widely used Option ARM indexes.
 
12-Month Treasury Average (MTA)
 
The Monthly Treasury Average, also known as 12-Month Moving Average Treasury index (MAT) 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 and CODI indexes generally fluctuates slightly more than the 11th District COFI, although its movements track each other very closely, as illustrated on our historical graph.
 
The MTA and COFI-indexed ARMs work much the same way. ARMs tied to the MTA index may have the potential for negative amortization (like those tied to the 11th District COFI). The MTA is the most widely used Option ARM loan index.
 
Note: The MTA index is also sometimes referred to as the 12-Month Moving Average Treasury (MAT).
 
Prime Rate
 
The Prime Rate is the interest rate charged by banks for short-term loans to their most creditworthy customers whose credit standing is so high that little risk to the lender is involved. Only a small percentage of customers qualify for the prime rate, which tends to be the lowest going interest rate and thus serves as a basis for other, higher risk loans.
 
The rate is almost always the same amongst major banks. Adjustments to the prime rate are made by banks at the same time; although, the prime rate does not adjust on any regular basis. The prime rate is not very volatile index however it generally rises quickly but declines very slowly.
 
Many home-equity loans and lines of credit are tied to the prime rate as published in the Wall Street Journal. The Journal number is derived from the rate posted by at least 75 percent of the 30 largest U.S. banks.
 
Cost of Savings Index (COSI)
 
This index is the weighted average of the rates of interest on the deposit accounts of the federally insured depository institution subsidiaries of Golden West Financial Corporation (GDW). All of the depository institution subsidiaries of Golden West Financial Corporation operate under the name World Savings.
 
World Savings receives money from consumers in the form of deposits and lends money as home or other loans. The interest rates in effect on these deposits are the basis for the COSI index. It is not based on actual interest paid, but rather the weighted annualized average of all interest rates in effect on World Savings deposit accounts on the last day of each month.
 
The COSI adjusts monthly and has a one-month reporting lag. It is computed on the last day of each calendar month and is announced on or near the last business day prior to the fifteenth day of the month.
 
The Cost of Savings index considered to be among the most stable ARM indexes in the industry. It is one of the most widely used Option ARM loan indexes.
 
Many COSI-indexed ARMs often have minimum payment change caps (usually, up to 7.5% of minimum payment amount), as well as lifetime interest rate caps (usually, about 12%) but no periodic interest rate caps creating the possibility for negative amortization.
 
 

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