What Should You Do With Your ARM?
"What should I do with my ARM (adjustable rate mortgage)?" is the most common question mortgage lenders get these days. A borrower with an ARM may want to refinance into an FRM (fixed rate mortgage) in order to lower costs, stabilize payments or some combination of the two.
To find the best answer to the question, the borrower needs four pieces of information:
- The current rate on the ARM.
- The period until the next ARM rate adjustment.
- The current FIR (fully-indexed rate) on the ARM.
- The rate and other terms on the FRMs available in the current market
Most borrowers know the ARM rate they are currently paying and when the rate will adjust, but few know the fully-indexed rate (FIR). This is the most current value of the interest rate index used by the ARM, plus the margin—the amount that’s added onto a specific index to calculate the interest rate you are charged. The margin is partly based on the credit score you have at the time you apply for a mortgage. The index used and the margin are both shown in the note, while the current value of the index is easily available on-line. One website is HSH Associates, Financial Publishers.
The importance of the FIR is that it is the best available predictor of how your ARM rate will change. To calculate the rate on your loan when it adjusts, you need to know the index your ARM is based on—such as the one-year Treasury or LIBOR (London Interbank Offered Rate)—the current rate on the index and the margin that's added to get your full rate.
At the next adjustment date, the new ARM rate will reset to equal the index value at that time, plus the margin. (Note: One bright spot is that most ARMs have an annual cap, often 2 percentage points. Your annual cap can be found on your note.)
This generalization has to be modified slightly for four indexes: COFI (11th District Cost of Funds Index), CODI (Certificate of Deposit Index), COSI (Cost of Savings Index) and MTA (12-Month Treasury Average). Because these indexes lag the market, the best estimate of what they will be when your ARM rate is adjusted is their projected value 12 months ahead, not their value today.
When you have the information on your loan plus your latest balance, you can go to a website that calculates mortgage payments. If you click here: estimate your new payments you will have access to MSN Money.
For example if you took out a 5/1 ARM in late 2002 at 5.2 percent for $240,000. (A 5/1 ARM has a fixed rate for five years, and then converts to a one-year ARM.) Your current principal-and-interest payment is $1,318. At the end of 2007, assuming an annual cap of 2 percentage points, your rate could jump as high as 7.2 percent, upping your monthly payment to $1,588 (an increase of $270) on the remaining $220,647 loan balance. At the end of 2008 and all subsequent years you could also see an increase (up to 2 percent) in your principal-and-interest payment.
Index rates may also drop and in that case your monthly payment could decrease.
