If your ARM is due to adjust this spring, your best move may be to allow it. Don’t rush to refinance — your rate may be adjusting lower.
It’s because of how adjusted mortgage rates are calculated.
First, let’s look at the lifecycle of a conventional, adjustable rate mortgage:
- There’s a “starter period” of several years in which the interest rate remains fixed.
- There’s an initial adjustment to rate after the starter period. This is called the “first adjustment”.
- There’s a subsequent adjustment until the loan’s term expires. The adjustment is usually annual.
The starter period will vary from 1 to 10 years, but once that timeframe ends, and the first adjustment occurs, conventional ARMs enter a lifecycle phase that is common among all ARMs — regular rate adjustments based on some pre-set formula until the loan is paid in full, and retired.
For conventional ARMs adjusting in 2011, that formula is most commonly defined as:
(12-Month LIBOR) + (2.250 Percent) = (Adjusted Mortgage Rate)
LIBOR is an acronym for London Interbank Offered Rate. It’s the rate at which banks borrow money from each other. It’s also the variable portion of the adjustable mortgage rate equation. The corresponding constant is typically 2.25%.
Since March 2010, LIBOR has been low and, as a result, adjusting mortgage rates have been low, too.
In 2009, 5-year ARMs adjusted to 6 percent or higher. Today, they’re adjusting near 3.000 percent.
That’s a big shift.
Therefore, strictly based on mathematics, letting your ARM adjust this year could be smarter than refinancing it. You may get yourself a lower rate.
Either way, talk to your loan officer. With mortgage rates still near historical lows, Cincinnati homeowners have interesting options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.
For some homeowners, electing to take an adjustable rate mortgage over a fixed rate one can be matter of budgeting. ARMs tend to carry lower mortgage rates and, therefore, lower monthly mortgage payment as compared to a comparable fixed rate loan.
Relative to fixed rate mortgages, current ARM pricing is excellent. Freddie Mac’s weekly Primary Mortgage Market Survey puts the 5-year ARM mortgage rate lower than the 30-year fixed rate mortgage rate by 1.02 percent.
On a $250,000 home loan, a 1.02 differential yields a payment savings of $149 per month.
ARMs are not for everyone, of course. Over time their rates can change and that can frighten people. An ARM can finish its respective 30-year lifespan with a mortgage rate as much as 6 percentage points higher from where it started. Some homeowners won’t like this.
Other homeowners, however, won’t mind it. For this group, the ARM can be a terrific fit. Especially with the huge, relative discount in today’s pricing.
A few scenarios that should warrant consideration of a 5-year ARM include homeowners that are:
- Buying a new home with the intent to sell within 5 years
- Currently financed with a 30-year fixed mortgage with plans to sell within 5 years
- Interested in low payments; comfortable with longer-term rate and payment uncertainty
In addition, homeowners with existing ARMs due for adjustment may want to refinance into a new ARM, if only to push the first adjustment date farther into the future.
Before choosing to go with an ARM, speak with your loan officer about how adjustable rate mortgages work, and their near- and long-term risks. Payment savings may be tempting, but with an ARM, payments are permanent.
When adjustable-rate mortgages are on the verge of adjusting, a common concern among homeowners is that their mortgage rates will adjust higher.
Well, this year, because of the math of how ARMs adjust, homeowners in Madeira and around the country are seeing that mortgage rates on ARMs can sometimes adjust lower, too.
Adjusting conforming mortgages are adjusting to as low as 3 percent.
As a quick review, here’s the timeline for most conforming adjustable-rate mortgages:
- There’s a “starter period” in which the interest rate remains fixed. This can range from 1-10 years.
- There’s a rate change after the starter period. It’s called the “first adjustment”.
- Subsequent, annual adjustments follow until the loan “ends”. This is usually after Year 30.
The adjustments each year are based on a math formula that’s included in the contract with your lender. It’s surprisingly basic. Each year, your new, adjusted mortgage rate is equal to the sum of some constant — usually 2.25 percent — and some variable. The variable is most commonly equal to the 12-month LIBOR.
As a formula, the math looks like this:
(Adjusted Mortgage Rates) = (12-Month LIBOR) + (2.250 Percent)
LIBOR is an acronym standing for London Interbank Offered Rate. It’s an interest rate at which banks borrow money from each other — very similar to our Fed Funds Rate here in the United States. And also like our Fed Funds Rate, LIBOR has been low lately.
As a result, adjusting mortgage rates have been low, too.
In 2009, 5-year ARMs adjusted to 6 percent or higher. Today, ARMs are adjusting to 3.000%.
Based on the math, you may want to let your ARM adjust with the market year. Or, if you plan to keep your home long-term and have concerns about adjustments in 2011 and beyond, it may be a good time to open a new ARM. The same forces that are driving down LIBOR and helping to keep mortgage rates low overall, too.
Consider talking to your loan officer and making a plan. With mortgage rates as low as they’ve been in history, most homeowners have options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.