The CMT Index is complicated and can be hard to explain. In this article, we hope to provide you with accurate, concise, and clear information about the CMT and how it affects you as a borrower.
What Is the CMT Index?
CMT stands for Constant Maturity Treasury. It’s an index based on the average monthly yield of various Treasury securities (the monetary benefits these Treasury securities accumulate each month). Treasury securities are bonds given out by the federal government, and the CMT is published by the Federal Reserve Board. The United States Treasury determines the yields of Treasury securities, and the CMT index is very responsive to changes in the economy and general market. The one-year CMT is adjusted to reflect constant maturities of one year. When it comes to home loans, numbers yielded from this index are often used by mortgage lenders to determine the cost of ARMs and other variable-rate loans. Lenders then add a margin to the index, which determines an individual’s interest rate on these loans. So when the index fluctuates with the state of the economy, so does the margin, and so do your interest rates.
In general, constant maturity yields that come from the United States Treasury fluctuate very little, meaning they also carry little risk. But that doesn’t mean the risk totally disappears with ARM loans. So lenders will compensate for risk that borrowers bring to the table by raising the interest rate. For instance, let’s say when you apply for a loan, the one-year constant maturity rate is at 5 percent. The lender may charge you 6 percent to account for risk factors that you have (these could include a high DTI, an imperfect credit score, or a fluctuating income). This 1 percent increase is also how the lender profits from your loan.
In addition to the one-year CMT, there’s also a three-year and a five-year.
The CMT Index and VA Loans
When it comes to the VA Hybrid ARM loan, the initial fixed interest rate is determined by the lender and is based on the borrower’s qualifications and level of risk. After the initial fixed period of the Hybrid ARM loan, the rate becomes adjustable. At this point, the rate begins to be affected by the CMT index; specifically, it is calculated by adding current CMT index values to the margin that the lender and the borrower agreed upon when the loan closed. For example, let’s say your VA Hybrid ARM loan was set at a margin of 2 percent. Let’s also say the CMT index at the time was 0.23 percent. Your interest rate then, once it became adjustable, would adjust to 2.23 percent from what it had been throughout the fixed-rate period. Your loan’s margin never changes throughout the life of your loan, so, however the CMT index changes, your adjustable interest rate will do the same. Here’s this concept illustrated in a math problem:
Index (0.23 percent) + Margin (2 percent) = Interest Rate (2.23 percent)
Luckily, the CMT index isn’t super volatile. This is the primary reason why many lenders choose it to determine ARM rates. The VA in particular hopes for a stable CMT because they’re guaranteeing to lenders a large percentage of the VA loans. In this case, the borrower’s interests and the VA’s interests line up: neither party wants to invest in a loan with interest rates likely to skyrocket at any given moment. In an absolute worst-case scenario where the borrower couldn’t keep up with the higher expense, the VA would have to pay up on that loan. And for the borrower, they could default on the loan and even lose their home. Thankfully, there are also interest rate caps in place with VA adjustable-rate loans. ARM rates cannot rise any more than 1 percent each year and no more than 5 percent over the life of the loan. This protects the borrower from any unreasonable jumps in the index.
What Does the CMT Index Measure?
In short, the CMT measures the return on treasury securities. To put it in a more understandable way, the CMT measures the rate at which an investment should be considered risk-free. In other words, if an investment is considered risk-free (like a savings account), it should have an interest rate comparable with the current CMT, or the CMT at the time the investment was made. Here’s more from Bankrate:
Investors and those following the movement of interest rates look at the movement of Treasury yields as an indicator of things to come. Their rates are considered an important benchmark: Because Treasury securities are backed by the full faith and credit of the U.S. Treasury, they represent the rate at which investment is considered risk-free.
The CMT is not very volatile. In fact, it is because of how placid it is that the VA chose it to base hybrid ARM interest rates off of. The VA has an interest in the loan because they are guaranteeing a percentage of it, so naturally they aren’t going to want to slap their guarantee on a loan based on an index that is likely to drive borrowers’ interest rates up 5 percentage points in just a few years. Your interests and the VA’s interest line up in this instance.
Other Indexes Used for ARM Loans
Aside from the one-year CMT index, lenders also base ARM rates on an index called the Lindon Inter-Bank Offer Rate, or LIBOR. This index is much more volatile than the CMT: its rates change more drastically in shorter amounts of time. Sometimes, LIBOR rates can be as much as half a percent higher than CMT index rates. However, LIBOR rates are also prone to jump down as often as they jump up, so depending on the direction, basing ARM rates off the LIBOR index could be optimal or disastrous.
Pay attention to margins when you’re shopping for a VA loan, and keep in mind that you can negotiate them with your lender.
For you as a borrower, that’s really all you need to know about the CMT index. Remember thaIf you have more questions about the CMT or about VA hybrid ARMs in general,
We at Low VA Rates want our customers informed and involved in the home loan process. To learn more about how the CMT and other indexes will influence your unique financial situation, give us a call, and you’ll be put in touch with one of our experienced loan officers.