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Facts about Your Adjustable Rate Mortgages

Monday, March 10, 2008 posted by Tommi Crow

Getting Screwed    Is refinancing your Adjustable Rate Mortgage the right choice?    Read the truth about ARM’s, to determine if holding onto your old loan is the right thing to do.

Definitions: 

  • Adjustable Rate Mortgage:  A mortgage with an interest rate that may change, usually in response to changes in the Treasury Bill Rate or the Prime Rate.  The purpose of the interest rate adjustment is to bring the interest rate on the mortgage in line with market rates. The borrower is protected by a maximum interest rate (called a “ceiling” or “cap”), which may reset annually.   ARMs usually start with better rates than fixed rate mortgages, in order to compensate the borrower for the additional risk that future interest rate fluctuations will create.
  • ARM:  Acronym for Adjustable Rate Mortgage.
  • Index:  An Index fluctuates with the economy and serves as an indicator or guide point for current interest rates.   Lenders use a published Index, which varies, to adjust interest rates as the economic conditions change.   Common Indexes for ARMS might be the One-year Treasury Security or the Prime Lending Rate.   The actual Index for any US Security can be found in the financial section of your newspaper, your bank or from a source such as the Wall Street Journal.
  • Margin:  A Margin is defined as the number of percentage points the lender adds to the Index to calculate the ARM interest rate at each adjustment period.  The Margin will be locked in at closing and remains fixed during the life of the loan term.  The Margin is not impacted by upswings or downswings in the economy.
  • Rate Caps:   Rate Caps are a safe guard, which limit how much loan interest rates can increase over a specific period.  Caps are set by the lender at closing and do not change with the economy.
  • Rate Ceiling:  The Rate Ceiling is the top or maximum interest rate the lender can charge, regardless of the economy.  The ceiling is set by the lender at closing.   

 

4 Ways to determine if Refinancing is in your Best Interest   

  1. Learn how the new interest rate for your Adjustable Rate Mortgage will be determined.   Lenders use a published “Index”, as a reference point, then they add a fixed number of percentage points, called a “Margin” to the Index, in order to establish the new interest rate you will pay. 

      For example:  If your Loan specifies the “90 Day T-bill Note” as the Index with a  2% Margin, the calculation is:    

                       The 90 Day T-Bill note (Index) at 2.160%                                  PLUS, a 2% Margin                         EQUALS a new interest rate of 4.160%.   

  1. Check with lenders to determine what the current interest rates would be for a new, Fixed Rate or ARM.   
  2.  Ask your lender for a truth in lending statement that discloses the amount of money you will pay at closing for the new loan.
  3. Do the Math.   Divide the loan closing costs by the amount of money you save per month on the new mortgage versus the old one.   The number shown will determine your break even, or the number of months you will need to stay in the property to recoup the closing costs. 

         Example:    If a new loan reduces monthly payments by                             $250 per month and closing costs were $7000,

                            you would need to stay in your home for 

                           28 months to break even.  If you don’t plan to stay

                           that long, refinancing will cost you money. 

  1. Keep in mind that if you refinance, you lose the number of years you paid into the Existing Loan.   For example, if you have paid your original 30 year loan for 5 years, the loan would be paid off in 25 years.  If you refinance, the loan starts over at year one, which means 30 years until you are debt free.

 

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