DesPortes: Do you know where your adjustable mortgage rate is? (column)
June 1, 2018
If you are currently in an adjustable rate mortgage, then do you know where your ARM is? Silly-sounding question, I know, but it is a vitally important one right now.
Personally, I have used ARMs to finance properties and have put countless clients and borrowers in to ARMs to finance their homes. For the right borrowers and the right circumstances, financing a home with an ARM can be a very sophisticated, savvy and beneficial financial tool. Deciding to use such loan programs requires an in-depth conversation with, and understanding from, the borrower as to the exact details and nuances of such a mortgage.
In most scenarios, ARMs have a lower interest rate than a fixed rate mortgage which is why borrowers select this option to finance their home. That part is easy enough to understand. Comprehending the big picture of the financing is a little more complex.
For starters, I will outline a few of the basic principles of nearly all adjustable rate mortgages. The term of the loan is 30 years, meaning that the loan would pay off in full after 30 years. However, the initial offered interest rate is only fixed for a certain period of time. Three, five or seven years is the typical fixed-rate period of ARMs. Over the remaining term of the loan, to the 30-year mark, the rate will adjust one of two times per year. Current market conditions as defined by the US treasury or the LIBOR index are added to a margin or mark-up charged by the lender to calculate the rate of adjustment. Caps are placed on the rate to put a stop on how high or low the rate of adjustment can be.
As an illustration, a 5/1 ARM at 4 percent would break down as follows: 30-year amortization of the loan, a fixed interest rate of 4 percent for five years, then once per year adjustments to the interest rate in years six to 30. Typical caps of the loan may dictate that the maximum rate of adjustment would be 5 percent above the start rate, or 9 percent in this case. The margin would be 2.5 percent which would also serve as the lowest the rate could adjust to and a typical index would be the 1 Year LIBOR index. Two percent higher or lower would be the maximum the rate could adjust by on any given period after the fifth year.
But the question remains, where is your ARM? Has the fixed rate period already expired and has the interest rate already begun to adjust on an annual basis? Or is an annual adjustment imminent? Either way, or regardless of where the loan is in its amortization, the financing scenario needs to be reviewed, analyzed and managed in the current environment.
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The 10-year U.S. Treasury index is flirting with and even closing above a 3 percent level, which has not been seen in many years, and the current one-year LIBOR index is at 2.77 percent. Therefore, if your ARM is in a period where it is or is close to adjusting, then you may be in for a rude awakening.
Personally I refinanced out of my ARM. If you are currently in an ARM, do you know where it is?
William A. DesPortes works for Central Rockies Mortgage Corp. He can be reached at 970-845-7000, ext. 103, and email@example.com.