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lquadland10 (< 20)

Help me fools and explain this to me.

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November 11, 2008 – Comments (4) | RELATED TICKERS: AUY , GLD , OIL

ARM. How does the ARMS resets keep going up when the prime lending rate keeps going down? This is not logical to me. A man on tv just now said this was to be his 3rd reset and this one would brake the bank. How does this work.

4 Comments – Post Your Own

#1) On November 11, 2008 at 10:17 PM, MarketBottom (29.30) wrote:

30 year morgage rates have gone up in the last year. The prime rate was historically for the very best quality credit. When GE has to go to the FED for money, you can only imagine how a subprime loan would fare.

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#2) On November 11, 2008 at 10:22 PM, lquadland10 (< 20) wrote:

gotch...

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#3) On November 11, 2008 at 10:55 PM, Imperial1964 (97.85) wrote:

The Fed doesn't set the rate the banks charge their customers. By "prime rate" I think you're referring to the "Fed prime rate", which is properly called the "Federal funds rate" on overnight lending.  I like to call it the "overnight interbank lending rate" because that is more descriptive.  Technically, the Fed doesn't even set this rate.  Through their open market operations manipulate the actual rate ("Effective Funds rate") so that it stays close to their "target rate".  It is in fact the targeted rate that is down to 1%.

Anyway, the Fed funds rate is basically what it costs to borrow money (money on deposit with the Fed) from other banks.  But the overnight lending rate is not necessarily related to the rate people actually pay on their 30-year mortgages.

When a fixed rate mortgage is created, the bank typically determines the rate by something kinda similar to this:  They look at the 10-year US Treasury yield, which is 3.75%.  Then they add to it a "spread", which depends on how risky the borrower is.  For someone with a good credit score, low debt, and a sizeable downpayment, they may only add another 2% to cover the risk of default.  That would make 5.75%, which is fixed for the life of the loan.

For an adjustable rate mortgage, the bank typically picks a benchmark of a short-term interest rate like LIBOR, plus a spread, like the 2% above.  The difference is, when LIBOR fluctuates, so does the interest rate the borrower pays.

So, adjustable rates on existing mortgages change when the underlying benchmark (like LIBOR) changes.

However, the spread is set when the loan is originated or refinanced.  For both fixed and adjustable mortgages, both the benchmark rate and the spread the banks offer on new loans can vary over time, independent of the Federal Funds rate.  Particularly, both the spreads and LIBOR will rise in an environment of rising defaults.

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#4) On November 12, 2008 at 9:58 AM, lquadland10 (< 20) wrote:

Shoot the bankers are making out like bandits. I am so glad the house was paid by cash and not all of the problems. I like cash and carry it makes life so much easier and they you don't have to pay the intress on all of it. They get enough of my money as it is.

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