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Posted July 11, 2012
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For U.S. homeowners with adjustable-rate mortgages, the last few years have worked out quite nice. With LIBOR held (artifically) low, adjusting mortgage rates have adjusted downward -- in some cases below 3 percent. However, with 30-year fixed rate mortgage rates headed to 3.500%, it may be time to switch to a fixed-rate loan.
There's good reason to switch from ARM to fixed right now.
ARMs Adjust Based On LIBOR
Adjustable-rate mortgages are different from fixed-rate mortgages in that their interest rates can change over time. Because of this interest rate risk, ARMs sometimes get a bad rap.
This was especially true last decade when homeowners' mortgage payments were rising during a period of extreme job loss, a scenario which put families at risk for foreclosure. Railing on ARMs made for good headlines, but multiple studies showed that it wasn't adjusting ARMs that sparked the foreclosure crisis -- it was reductions in household income; or medical bills or illness; or divorce.
In 2007, one servicer reported that just 1.4% of foreclosures were the result of ARM rising payments.
And as the press vilified ARMs, what was often overlooked was that adjustable-rate mortgages can't just "adjust willy-nilly" to the detriment of ARM-holding homeowners. Every conforming mortgage has set rules by which an ARM can adjust.
ARMs work like this :
- For some fixed period of time, usually 5 or 7 years, the ARM mortgage rate remains constant
- When the fixed period ends, the mortgage rate changes, based on a preset formula
- Every 12 months thereafter, the mortgage rate changes again, based on the same preset formula
The key to an ARM is that formula; the math by which that rate adjusts. The formula is often simple addition -- just add 2.25% to the current 12-month LIBOR rate and that's your new ARM rate. Five years ago, ARMs adjusted to 7.500 percent.
Today, ARMs adjust to near 3.250%.
With ARMs At 3.25%, Look At Fixed Rates Near 3.50%
Homeowners with adjusting ARMs have been lucky.
We're only now learning that LIBOR -- the basis for interest
rate adjustments -- had been monkeyed with these past few years. LIBOR should have 50-300 basis points higher than its current levels. However, because bankers manipulated LIBOR to their benefit, the benchmark rate was held artificially low.
With the story broke, LIBOR is expected to rise. It leaves ARM-holding homeowners with 3 basic choices :
- Do nothing. Let the loan adjust higher with LIBOR and revisit the ARM in 2013.
- Refinance the ARM to a new ARM at today's low ARM rates.
- Refinance the ARM to a new fixed rate mortgage at today's low fixed rates.
Each option merits consideration.
If you do nothing with your ARM and allow it to adjust, your new, adjusted mortgage rate will be based on today's LIBOR, and that should put your rate near 3.250 percent. 3.250% is a fair mortgage rate and you'll get to keep it for the next 12 months, at least.
If you think LIBOR will rise with the LIBOR-fixing story in the open, but you still want an ARM, you can refinance into a new ARM at, or below, 3 percent, according to Freddie Mac's weekly mortgage rate survey. You should expect to pay closing costs and points to get a sub-3 percent mortgage rate.
Or, if you think today's fixed-rate mortgage rates are too good to pass up, you can refinance into a 30-year fixed rate mortgage near 3.500% or a 15-year fixed rate mortgage near 2.875%. Again, with points and closing costs.
Loans with no closing costs are available, too. Be sure to ask your loan officer.
Consider Today, Plan For Tomorrow
ARM-holding homeowners know their LIBOR risks. LIBOR will affect ARM pricing in both the near- and long-term. Mortgage rates may be great today, but what about next year? Or the year after that?
Have a plan because LIBOR will likely rise suddenly and sharply someday, then "regular" mortgage rates will, too. Today's low rates are at risk.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.