Adjustable rate mortgages come in many flavors
Will your ARM (adjustable rate mortgage) end up costing you your leg? As a few locals have found out, that great rate you got a few years ago on your adjustable rate mortgage is turning into a nasty surprise, while for others their rate is actually dropping, for now at least.
Adjustable rate loans adjust in a variety of ways, depending on how they were written. Just because your dog sitter’s next door neighbor saw his ARM drop to 4 percent does not mean your loan is going to drop as well. It could explode in your face, as did one I saw recently that went from 6 percent up to nearly 9 percent.
There are several components that determine how an ARM will adjust, depending on how the loan was written. Do not assume yours is just a garden variety ARM and will do you no harm. There are good ARMs and there are terrible ones. Understanding your ARM might be easy or it might take a mortgage expert.
To start, get your promissory note out and check to see if it also has an adjustable rate rider attached to it. The first thing to look for is the date of the first adjustment. Next, figure out how often it adjusts. Most adjust once a year after the initial fixed period, but some adjust quarterly or semi-annually.
Third, look for the index it is tied to. Probably a dozen indexes have been used over the last few years and which one your mortgage is tied to may relate to how often your ARM adjusts. If your index is a LIBOR (London Interbank Offering Rate), determine which rate it is. Most LIBOR rates are for one, three, six and 12 months and it is crucial to know which index you are tied to.
Another common index is called the 12-MTA (12-Month Treasury Average). When you look up your index value be sure you have the correct one, because they can be very confusing and many Web sites only list the one- and three-month indexes. Also try to find the most current measure as many have fluctuated by several points in the last few months.
The fourth thing to look at is the margin (or mark-up) that is added to the index. This will determine what your rate will reset at. The lender picks the stated day or week the index value will be pegged and adds to it a markup called the margin.
Typically, the margin will be from 2.25 up to 3 percent. If you have a 2.25 percent margin and the current index is a 3.5 percent, your new rate will be the total of the margin and the index, or 5.75 percent.
If you have a loan that has a 6 percent margin and the index was at 2.25 percent, your rate could go as high as 8.25 percent. Those are bad, bad loans to be in.
Beware also if you call your lender and ask what your rate might go to. I have seen some big name lenders try to deliberately scare borrowers into getting a new loan.
One of my clients recently called her lender (the second-largest financial institution in the world) to inquire about her loan. The employee warned her that her rate was about to go to 9 percent and promptly offered to refi her into a lower rate.
She called me to give me a lecture about the awful loan I had gotten for her five years ago. I investigated the situation and we determined her loan was actually going to drop a half-point. As she was planning to sell within the year keeping the loan was a perfect fit. I think the lender saw the rate was going to drop and wanted to put her into a 6 percent loan when she didn’t need a new one at all. That is both unethical and a violation of Colorado law.
Keep in mind that what goes down may well go up and if you are planning to be in the house for several years now might be a good time to get a fixed rate loan as rates are at historic lows.
Your mortgage is your largest obligation and managing it takes some effort but it can be worth tens of thousands of dollars to you to get it right.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and can be reached at 970-748-0342. He welcomes mortgage-related inquiries.