Some of the lowest rate mortgages out there right now are ones written years ago that were set up as adjustable rates. Many borrowers are loving the fact they have rates in the mid 2 to low 3 percent range, for now at least.
The reason rates are so low on ARMs is because they are tied to a particular index plus a margin. Many are tied to the six month or one year LIBOR, which stands for the London Interbank Offering Rate. That is the rate banks loan each other money at. The last few years that rate has been in the 1/2 percent range.
Typically the margin, which is the amount the rate is marked up over the index, is 2.25 to 3 percent. So if your rate adjusted recently you likely have a rate of about 3 percent. On top of that your home is probably worth 5 to 10 percent more than it was a year ago, and you are likely feeling a bit cheerier these days about your personal finances. Indeed, ARM’s that were taken out more than five years ago have performed wonderfully.But every good party comes to an end and hangovers can be ugly if we over indulged in what seemed like a fine idea at the time.
The Libor rate fluctuates like any interest rate, and though never in lock step exactly with any other index, it moves in concert with other indexes.
In the last month, the yield on the 10-year T-bill has increased over 1/2 percent from the mid 1 percent range to the low 2 percent range. While there is great debate over the future of bond yields that debate is no longer on the direction. It is simply how fast and how high.
Back in the summer of 2003 the yield on the 10-year bond surged from 3.1 to 4.56 percent, which saw a similar jump in the LIBOR, which caused a similar jump in mortgage rates.
Recently, many Wall Street analysts have been signals that they see the yield on the 10-year bond going as high as 4 percent in the next few years. That would mean the LIBOR might well follow and that would cause many adjustable rate loans to adjust upwards significantly.
Here’s an example. If you took out a $400,000 loan five years ago and it is now adjusting annually you are likely at about 3 percent and owe about $355,000. Your P&I should be about $1,686 (not counting taxes and insurance). Your loan most likely has a cap of adjusting 2 percent a year.
If your rate suddenly jumped from 3 to 5 percent your payment would then go to $2,075, or $389/mo. or a 23 percent increase.
The solution to this dilemma depends on your plans for keeping the house. If you were to refi to a new 30-year loan you could do that at about 4.25 percent today, which would make your payment $1,746.00.
If you think you are moving in 5-7 years, you might opt for a new adjustable. Currently those are in the low 3 percent range, so you could keep your rate close to what it is. But in 5-7 years you may be back in the same spot and 4 percent will be no where to be found.
One thing is for sure, if you wait until your adjustable suddenly jumps up, it will likely be too late to do anything you will really like.
Chris Neuswanger, a mortgage loan originator with Macro Financial Group in Avon, may be reached at 970-748-0342. He welcomes inquiries from readers.