Examine loan alternatives if you have an adjustable-rate mortgage before the rate on your ARM resets, said Michael Gentile, an experienced Santa Monica REALTOR from Santa Monica. Knowing the conditions of your loan by checking your ARM’s original paperwork is a smart idea.
Areas You Need to Familiarize With
Image via WikipediaIndex. The interest rate you settle on an ARM is based from a widely-followed index. London Interbank Offered Rate or LIBOR is a common index used by big banks.
Interest Rate Cap. It tells you up to what amount your rate can go up in a given duration of time. Periodic cap tells you the rate increase limit from one period to another (e.g. yearly rate). Lifetime cap is the max amount your rate can go up all throughout the loan.
Adjustment Period. Simply, the frequency in which your rate changes.
Margin. It is the percentage you pay below or above an index. “Libor plus 3” means that you will settle an interest rate 3% points above LIBOR. A 3% margin plus a 3%LIBOR results to a 6% mortgage rate.
Determine your length of stay in your house after knowing your ARM terms. If you plan to stay under five years, refinancing into another ARM may be a good idea. People who will stay at their house for a longer period should opt for a fixed-rate mortgage.
Refinancing Alternatives
Use an online ARM calculator to determine your monthly payment after your ARM resets to a higher interest rate. This will give you an idea if you need to jump to another alternative. You can either refinance a 15 to 30-year loan with a lower monthly payment or get a 5/1 ARM that gives you a low fixed-rate for the first five years.
5/1 ARM can be good but the problem is when the introductory rate expires, wherein the rate goes up to what you are paying on your previous loan. It can even go beyond that on the following years, especially if you live in a rising-interest-rate environment. 5/1 ARM is advisable if you are planning to sell your house after 5 years. Fixed 15 to 30-year loan are for those who are staying for the long haul.
Tips in Refinancing
In making a decision about refinancing, weigh the breakeven points and closing costs. The usual closing cost on a refinance is 3% to 6%, according to Federal Reserve. Avoid prepayment penalty on ARM.
You have to consider the following in evaluating your options:
- Your job security.
- Effects of late payments/too much debt on your credit score.
- Lending market trend in the future.
As a precaution, don’t spend the money you are saving the intro period of ARM. This can be applied to your principal in case your ARM resets before you can refinance. Entertain the possibility that you may have to sell your house. Perhaps get a cheaper housing plan or rent until you can afford a new home.
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