What do to About Your ARM that is Adjusting Soon?
Tips for Handling an Adjustable Rate Mortgage
Don’t Just Refinance Your Mortgage
ARMs (Adjustable Rate Mortgages) can be a terrific tool to manage cash flow, especially if you can predict how long you will have the mortgage. ARMs have several important components that affect rate adjustments. When your ARM is about to adjust, you must gather some information and get expert advice before taking action. You should not assume that you should refinance, because it may not be the best option.
What You Need to Know Before Doing Anything
Most ARMs have a fixed initial interest rate for a number of years. (Note: an Option ARM works differently and is beyond the scope of this discussion.) After the fixed period, the interest rate could adjust periodically based on an index and a margin (subject to caps), and the adjustment period. If the ARM has an interest-only feature, then you will have to begin paying back principal at some point; some ARMs will remain interest-only for several years after the fixed period. So you need to know: the fixed rate period, the interest-only period (if applicable), the caps, the index, margin, and adjustment period. Although all of these should have been disclosed to you, most people don’t know them offhand.
How Caps Work on Adjustable Rate Mortgages
Caps add to the rate to determine the maximum adjusted mortgage rate, and limit the adjustment in three ways: first-time cap, periodic cap, and lifetime cap. The first-time cap limits the first adjustment which may be larger than later adjustments. The periodic cap applies to subsequent adjustments, usually every 6, 12, or 24 months depending on your adjustment period. The lifetime cap limits the total possible adjustment. Caps limit both increases and decreases in rate, and may apply to initial or adjusted rates.
Calculating Your New Interest Rate and Payment
The adjusted rate is the sum of an index and a margin, both disclosed in your loan documents, rounded to the nearest .125%. Most lenders use a published market index such as the 1-year Treasury or 1-year LIBOR. The applicable caps limit the adjustment. Normally you are notified 45 days in advance of the change. Your new mortgage payment is calculated using your remaining balance and the loan type (amortizing or interest-only).
What to do When You Know the Numbers
Once you know the numbers, take them to a Certified Mortgage Planning Specialist® for analysis and advice about alternatives. Your CMPS® will sometimes counsel you to accept the new rate until a refinance makes sense. Sometimes, your rate will not change at all, or even decrease! If your loan won’t adjust for a while, and your rate is below current market, you may not need to act. However, if you can’t afford the adjusted mortgage rate, you’re going to need expert help.
With ARM adjustments, you have to know all the facts and consult an expert before you make a decision.
About the Author - Kabir Mahadeva
Kabir Mahadeva helps clients to create and preserve wealth by integrating their mortgage with their overall financial plan. As a Certified Mortgage Planning Specialist®, he is one of a very select number of professionals who have earned advanced certification in assisting clients to achieve financial goals including funding retirement, paying for college, optimizing cash flow, reducing tax costs, and increasing net worth. Click here to read more about Kabir Mahadeva.
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