Fix Your ARM
Adjustable rate mortgages, or ARMs are loans that can at some point in the future adjust, up or down, based upon a preselected index, margin and cap. The adjustment can take place every six months, once per year or in the case of a hybrid loan, fix for an initial term for 3,5,7 or even 10 years before an annual adjustment.
An ARM adjusts by adding the margin to the loanís index where the new rate will remain until the next adjustment period. Common indexes associated with todayís ARM programs include the London Interbank Offered Rate, or LIBOR and the Monthly Treasury Average, or MTA. A typical margin is 2.25 or 2.50 percent.
For example, say you have an ARM and today is your adjustment date. Your lender will identify the price of the current index and add your margin. If your index is based upon the MTA, your starting point is around 0.17. Using an index of 2.25, your fully indexed rate, the one your next set of payments are based, is 0.17 + 2.25 = 2.42 percent.
Compare the 2.42 percent rate you adjusted to with a fixed rate today of 3.50 percent. With a $300,000 mortgage, the principal and interest payments are $1,1172 and $1,347 respectively. In this example, your interest rate dropped when your ARM adjusted to a lower rate and you didnít have to refinance your loan; you just sat there and waited.
So what do you do if you have an ARM today or a hybrid that will soon adjust? The prudent answer, as long as you intend to own your property for any length of time, is to refinance out of an ARM now and into a fixed rate mortgage. After all, fixed rates wonít be this low forever, right?
And what about a hybrid loan? Hybrid loans are in fact ARMs but start out with a rate that doesnít adjust until after an initial period with the most common hybrids fixed for three or five years. If you have a 5/1 hybrid and are in year three of your loan, your rate is somewhere around 4.75 percent with a payment on a $300,000 loan at $1,564.
Do you refinance your hybrid into a fixed rate now or wait? Again, the prudent answer is to refinance out of any ARM as long as you intend to keep the property.
Yet so many borrowers with ARMs today have been reluctant to let go of their extra-low rate as theyíve watched their monthly payment shrink as rates fall at no cost to them whatsoever. Who wants to give up a loan program in exchange for an interest rate that today is at least a full percentage higher than what a fixed program can offer?
That makes complete sense, but there are borrowers with ARMs right now that are keeping a close on interest rates and when, not if, rates begin to tick upward, there will be a mad dash to the closest mortgage lender to fix that rate in.
You canít predict the future unless you create it. That means if you refinance out of an ARM today, you know exactly what your rate will be for the remaining term of the loan. Prudence does rule here. Dump the ARM and lock in the fixed rate loan.