Is it Time For A Refinance Mortgage Loan? Going From Adjustable Rate Mortgage (ARM) Instead Of A Fixed Rate Mortgage (FRM)
You have locked in a great initial borrowing rate on your adjustable rate mortgage. Pretty soon, your mortgage rate will be determined by current market rates. The time since you took out your home loan mortgage, borrowing rates have gone up thanks to a stronger U.S. economy. To get peace of mind and avoid fluctuating mortgage payments, is it time to switch from an ARM to a fixed rate mortgage loan? Should you go ahead with a refinance mortgage loan?
How Does An Adjustable Rate Mortgage Work?
An ARM is a combination of a fixed rate mortgage and an adjustable rate mortgage. Initially, the mortgage rate is fixed, usually 3 to 5 years, and not for the full term of the mortgage loan.
Once the period of fixed mortgage rate is over, the borrowing rate becomes adjustable. The mortgage rate is based on a pre-chosen index. Depending on how the index behaves, the mortgage rate will change accordingly. The index could be pegged to the following: Treasury Bill Rates, The Prime Rate, Libor, 6 month CD rate and the average rate for loans closed, called the Federal Housing Finance Boards National Average Contract Mortgage Rate to refinace. The mortgage rate could be adjusted monthly, every quarter or annually depending on the feature of the home loan.
ARM Components
The ARM offers low rates to attract people to this type of loan since the initial rate is quite low. This is known as the Teaser Rate. There are several components that go in to calculating an adjustable mortgage rate:
Index: This is the variable rate used as a base to establish future rates of the mortgage loan. The index could be taken from various market rates depending on your mortgage lender.
Margin: This is the spread, a fixed number, added to the index to set the actual rate charged to the mortgage borrower. Example: The index is based on One Year Treasury Bills 3%. The Margin is 2%. The rate to the borrower is 5%. Rate = Index Rate + Margin.
Margin Adjustment Period: This is the duration for which the interest rate is fixed. If the adjustment period is one year, then the interest rate will remain fixed for one year, after which time it will adjust.
Adjustment Cap: This is the maximum the interest rate can adjust either up or down for each adjustment period. Example: The adjustment cap is 1 point, the index based interest rates since the last adjustment period went up 1.5 points. The most you will be paying would be 1 point due to the cap.
Lifetime Cap: The maximum mortgage borrowing rate charged over the duration of the adjustable home loan.
Conversion Options: Some ARM come with options to convert them to a fixed rate mortgage based on a pre-determined formula, during a given time period. Example: the 1-year Treasury bill adjustable may be converted to a fixed during the first five years on the adjustment date. Meaning, you have the option to convert during the 13th, 25th, 37th, 49th and 61st months of the loan.
Advantages Of An ARM
• If you intend to stay in your house only for only just a few years: Since initial interest rates are low at the beginning, you will get the benefits of an ARM.
• Interest rates have peaked: By opting for an ARM at the peak of the interest rate cycle, the successive rates will be lower as interest rates go down. Your monthly payments will be lower.
• Affordability: If current interest rates are very high, this may be the only loan option available to you. You may qualify for a loan easier as lender incorporates the gross monthly income and the monthly loan payment amount to determine how much you qualify. The monthly amount will be less with a lower interest rate so you may qualify for more.
A Lower Mortgage Rate Or Peace Of Mind?
According to Mortgage Bankers Association of America, one in five borrowers are opting for ARM versus FRM to get lower monthly mortgage payments and interest rates. Using this example of a $150,000 home loan, a 30 year fixed rate mortgage would carry a rate of 5.5 percent and the monthly payments would be $851. The same size adjustable rate mortgage with a rate of 4.125 percent for the first five years would have $726 in monthly payments. After the initial period, the rate could increase or decrease a maximum of 2 percentage points a year.
The homebuyer going for the ARM would save $10,230 in interest payments in the first 5 years. It’s quite evident that the benefits of an ARM are to be reaped early in its borrowing term. For those who intend to stay with their home for just a few years, this type of home mortgage loan should be considered. On the other hand, if you plan to be at your current home for a long time and want peace of mind, a fixed rate mortgage should be given consideration. Mortgage rates are coming off 40 year lows as U.S. economy activity picks up.
Labels: refinace, refinance mortgage loan
