Neuswanger: Adjustable-rate mortgages may soon go way up across the United States (column)
If you are one of millions of Americans who has an adjustable-rate home loan, then you’ve probably grown very complacent about it and been enjoying your low rates in the 3 percent range for the past 10 years or so. But it may be time to dig out that paperwork and take a sharp look at what can happen when your next anniversary comes around.
Typically, adjustable-rate mortgages are tied to the one-year LIBOR (which stands for the London Interbank Offering Rate, which is the rate at which banks loan one another money) plus a margin or markup of generally 2.25 percent to as much as 3 percent.
For the past 10 years or so, the LIBOR has been between 0.75 percent and 1.25 percent. This means if your loan had a margin of, say, 2.25 percent over the LIBOR, your interest rate ranged from 3 percent to 3.5 percent.
Recently, the LIBOR has been creeping up and currently is in the 1.7 percent range. So if you have a margin of 2.25 percent, then your next rate adjustment could be close to 4 percent. Many economists think it might rise to 2 percent by early next year, meaning many adjustable-rate loans could pop into the low 4 percent range.
Lock in a Rate
Depending on your situation, including loan amount, credit, income, property type and loan to value, there may still be a window to refinance and lock in a rate in the 3 percent range for the next five to seven years. We are seeing loans fixed for five to seven years in the high 3 percent range. It’s unlikely, though, that these rates will hold if the LIBOR does break 2 percent or is widely expected to shortly.
All adjustable-rate loans have annual interest rate adjustment caps, so your payment can’t jump by more than a specified amount per year, and most have a lifetime cap. Terms vary widely, so reading your promissory note will tell you what your caps are. The remaining balance of the loan is calculated at the current rate over the remaining years left on the original loan. If you are five years into your loan and had an original term of 30 years, the balance will be amortized over 25 years at the current indexed rate, plus the margin.
Many homeowners have been paying on their low-rate loans long enough that they are starting to pay a substantial amount every month in principal. Generally after about eight or nine years, as much as half the payment is going to principal every month. For those individuals, the right option might be to get a 1 to -20 year fixed-rate loan.
Refinancing these days is, at best, full of conflicting choices, and it takes a good long talk with your lender to explore the options and figure out what is best for your particular situation.
Just going for the lowest payment might actually cost you tens of thousands more in the long run. Factors such as how long you plan to own the home, your cash flow and savings goals all play into determining what is best. Lenders have software today that can run multiple scenarios and “what if” projections to help you make an informed choice.
What you do not want to do is ignore correspondence from your lender or wait and hope your loan will be the only one that won’t go up.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage-related questions from readers. His website and blog can be found at http://www.mtnmortgageguy.com.