Mortgage Loan Refinancing Options
Is your ARM hurting you? (ARM meaning adjustable mortgage rate.) If you’re like a good number of recent home buyers or those who refinanced their homes over the past few years, you may have selected an ARM as your mortgage choice. Now that interest rates are on the rise, you may be one of those home owners who are facing mortgage payment rate increases. And some home owners are finding it hard to come up with higher house payments.
Adjustable rate mortgages have their advantages. For one, they often have an initial interest rate that is lower than a fixed rate mortgage. But they also have a disadvantage—one day, their interest rate will change, and you may find yourself facing “ARM reset shock.”
This occurs when the initial period is up and the interest rate is adjusted, or reset, to the current rate. Your payment then changes accordingly. If interest rates have gone up during that time—or if the initial rate was an artificially low “teaser” rate—your payment may go up sharply.
This rate shock can be even greater if you have a hybrid ARM. These mortgages have a low initial rate that stays fixed for a set period—usually two to five years. During that time, it’s easy to forget about the possibility of future higher payments should interest rates rise. But they may rise significantly at the end of the fixed-rate period. And possibly continue to rise at every subsequent six- or 12-month adjustment period.
The impact can be even more pronounced in the case of an ARM that has a discounted initial rate—a rate that’s lower than it’s fully indexed rate. For an example, let’s assume you take out a $200,000 mortgage with a 30-year term, an initial one-year discounted rate of 4 percent and a fully indexed rate of 6 percent. According to the Federal Reserve Board’s Consumer Handbook on Adjustable Rate Mortgages, your first year monthly payments would be $954.83. But in the second year, when the discount period ends and the rate jumps to the fully indexed 6 percent, your payments would rise to $1,192.63. And if the index rate had also risen 1 percent during that period increasing the rate to 7 percent, your monthly payments would increase to $1,320.59. That’s an increase of $365.76 a month!
You could have a different kind of reset problem if you’ve been making the lowest allowable payment on an option ARM. These payments typically don’t cover all of the interest due on the loan, so your mortgage principal may actually be increasing. When the option ARM is recalculated, or recast—usually after five years—the higher balance is calculated in. Your payments can increase sharply, especially if interest rates have also risen. And the rate cap will not apply to this calculation.
