Vail Daily column: Time to get out of your adjustable rate mortgage?
The turmoil of the world’s economy has had one little heralded beneficiary, albeit many of these people might debate that designation. While governments have teetered on collapse, gold soared and plunged and oil prices collapsed, the one group who benefited were borrowers whose interest rates were tied to the demand for U.S. treasury bills.
The largest single group were homeowners who had adjustable rate mortgages. These loans, while often fixed for the first five or seven years, adjust annually thereafter in relation to a set interest rate (often the LIBOR, or London Interbank offering rate) plus a margin or markup between 2 and 3 percentage points.
The LIBOR has been below 1 percent for the last seven years. This means that millions of mortgage notes have adjusted to sit in the 2-3 percent range for the next 12 months. This has collectively saved homeowners not only tens of billions of dollars in interest, but in many cases has no doubt literally saved their homes as well, enabling them to afford payments when other household income was reduced, often drastically.
But economics always run in cycles, and history seems bound to repeat itself. What many homeowners have chosen to overlook or ignore is the history of the LIBOR rate. While it has been at a record low for the last seven years, history points out that the LIBOR has gone as high as the mid-7 percent range on occasion (1999 was the last time) and from 2005-2007 was in the mid-5 percent range.
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What that means is that a mortgage that is tied to the LIBOR plus a margin of 2.5 percent would have peaked out at nearly 10 percent in 1999. The payment on a $300,000 mortgage at 3 percent is about $1,264 per month. At 10 percent, it would be $2,632 per month.
Adjustable rate mortgages do have caps on how high and how fast they can rise. Generally it is set up as a 5/2/5 cap. What this means is the first time the loan adjusts (often after five to seven years) the rate cannot go up more than 5 percent. After that it cannot go up more than 2 percent above the previous year’s rate, or a max of 5 percent over the start rate.
The rate will always adjust annually up or down on the anniversary date of the loan to the selected index plus the margin, subject to the caps.
While I don’t think we are going to see a huge jump in the LIBOR rate anytime this year, it will in time probably tick upwards slowly. In the meantime, fixed rates are still at record lows (generally in the high 3 percent range for a conforming fixed rate) and not that far off of the low adjustable rate many are enjoying. In addition, loan closing costs can often be waived or significantly reduced depending on the particulars of the loan program selected.
If you think you might sell your home in the next few years and have an adjustable rate loan, then I’d probably suggest you sit tight. If you might stay in your place at least three to four years or more and have a adjustable rate loan , then I’d suggest you consider refinancing into a fixed rate.
Every Situation is Unique
However, every borrowers situation is unique, and some thoughtful number crunching is what should come first. We have software programs that are great for running scenarios and helping clients think through their options and I’ve helped many clients evaluate their situations. About half I advised to stay put and the other half will likely benefit from a refinance in the long run.
Chris Neuswanger is a loan originator at Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage related inquiries from readers. His blog and a collection of his columns may be found at http://www.mtnmortgageguy.com.