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My ARM is About to Expire; Now What?

Studies show that in 2007, almost $1.5 trillion (yes, that’s a “T”) worth of adjustable rate mortgages (ARMs) have already reset or are due to reset soon; that’s five times the number that reset in 2006! You might be asking why is there this sudden increase in mortgages up for adjustment? It’s the result of several factors coming together.

As many of you know, in recent years, interest rates have been at historic lows. To get the lowest rate possible, and leave the door open to potentially get an even lower rate in the future due to the adjustability feature, many home buyers chose an adjustable rate mortgage to save money in the short-term and hedge their bets that the market would go down in the future. The alternative was not nearly as attractive because the 30 year fixed had no savings to be realized and the benefit of a decreasing market was also not there. Many existing mortgage holders also took advantage of low ARM rates to refinance in order to obtain a lower payment and/or to draw funds from their home’s equity to spend elsewhere. Lastly, soaring home prices and low interest rates combined to make these options extremely attractive to homeowners.

My research with several reputable sources shows that nearly 25 percent of mortgages held today carry adjustable interest rates; that’s not surprising considering the savings they’ve provided over the past few years. Those of you that were in the market in 2003, for example, may recall the interest rate on a 30-year fixed-rate loan was around 6.5%, whereas ARM rates were under 4%; for a $200,000 note, that’s a monthly savings of $309.30! Who wouldn’t jump all over that?

Many of today’s ARMs are also hybrid products meaning they combine the features of both fixed rate and adjustable rate mortgages, typically starting off with several years of fixed payments before converting to an annually adjusted rate. Someone who took a 3/1 hybrid ARM in 2004 would have had a fixed interest rate for the first three years and would only now be facing an adjustment in 2007. This “reset phenomenon” will continue for the foreseeable future because those that got into the 3/1 ARM in 2005 will be resetting next year, those that got into the 5/1 ARM in 2004 will be resetting in 2009, the 7/1 ARM in 2004 will reset in 2011, etc.

The problem is that many ARMs due to reset this year will be doing so at a considerably higher interest rate. Not only have interest rates increased, but the gap between fixed and adjustable rate mortgages has narrowed significantly. Those who took out an ARM for less than 4% back in 2003 could see their mortgage rate jump to 7.5% after the adjustment. For that same $200K mortgage I mentioned earlier, that’s an increase of over $440 a month and many homeowners simply cannot afford the new payment.  This huge increase in a homeowners monthly payment is also fuel for the fire regarding declining home prices…sellers are willing to sell at deep discounts to get out from under that smothering mortgage payment.

But even if your mortgage is resetting at a higher rate, the news isn’t all bad. Before you freak, consider the following:

You’ve Benefited From a Low Initial Rate – Remember, the fact that you chose a low-interest ARM means you’ve most likely already reaped the benefit of saving several thousand dollars a year during the first few years of your mortgage.

Mortgage Interest is Usually Tax Deductible – Even though your payments may be increasing when your ARM resets, the fact that mortgage interest is usually tax deductible means there may be less net impact than you may expect on your overall finances.

You can refinance to a fixed-rate mortgage – If you’re concerned interest rates may continue to rise and want the security of knowing your monthly payment won’t rise to an unaffordable level, you have the option of refinancing to a fixed-rate loan.

Historically, Today’s Interest Rates Are Still Low – Twenty years ago any mortgage under 10 percent was a great deal. Today’s rates are still historically low.

You Chose the Right Mortgage if You Plan to Move Soon – Choosing an ARM was the right decision if it enabled you to save money during most of the years you lived in your home. Those savings should more than offset a short period of higher interest payments just before you sell your home.

You Have Options – If you’re worried about your adjustable rate mortgage resetting, you can calculate how much you will pay after your ARM adjusts by reaching out to me for a completely free Total Cost Analysis.

By knowing what to expect and by planning ahead, you can stop worrying about what the future may hold and start coming up with a solution that can meet your budget and financial needs.

Should I Buy Down My Rate?

When seeking a mortgage, borrowers often get fixated on a specific rate that has an emotional brink; usually something like 6.49% or any other number that we as humans find visually pleasing.

However, deciding to buy down an interest rate is far more complicated than just an attractive number up front.  Borrowers really need to look at their long-term plan for the home before moving forward.  After all, buying down the interest rate is an upfront cost with savings that will not be realized for many years to come.

The Scenario

  • You are offered a rate of 6.25% on a $250,000 fully amortized, 30 year fixed rate loan with no discount points
  • You have convinced yourself that you need a rate of 5.99% at a cost of one point (1% of the loan amount – in this case $2,500)
  • Your savings for buying down the rate to 5.99% will be $42.02 per month

Consider this: How long will it take you to recover the upfront cost?  $2,500/$42.02 = 59.49 months, or just short of five years.

This is the part that many people overlook; you need to decide how long you plan to stay in the home and how long you plan to stay in the loan.  If you sell or refinance before those five years have passed, simply put, you have lost money.  However, if you stick around a bit longer, the buy down will begin to make sense.

Another issue to consider is that many borrowers who have paid to buy down a rate will wait to refinance because they want to ensure they meet the savings they were originally going after when they bought down the rate; if the rates drop significantly, you could be missing great opportunities to save even more money.

As with most things, many parts of this situation are uncontrollable because of the often-unknown interest rate environment and, therefore, make this a difficult decision.

The Bottom Line: Paying points may make a lot of sense if interest rates climb significantly in the years after you buy down your rate, because you’ll likely stick with your current mortgage and see the savings through; the opposite is true in times when interest rates decline sharply. Beyond that, you may find a buy-down to be advantageous if you plan to live in the house – and not refinance the loan – for a very long time. With that being said, please take the time to analyze your situation to see if buying down your interest makes sense for you. I would be happy to help you think this through; call me.