Are Adjustable Rate Mortgages Worth Your Consideration?

December 15, 2010 by Leave a Comment

Recently I talked with a Seattle home owner who's considering refinancing their 30 year fixed rate mortgage for an adjustable rate mortgage.  Adjustable rate mortgages (ARMs) have fallen out of favor in recent years due to the mortgage melt-down.   I've never been a fan of option ARMs, however there is nothing wrong with adjustable rate mortgages as long as the borrower understands the terms and it's suitable for that person's financial scenario.   This home owner's financial plan is to be mortgage free in seven to ten years after his children are out of college.   Cash flow is important right now so he would rather not do a 10 or 15 year amortized mortgage.

You very well could be scratching your head right now thinking "with how low fixed rates are right now, why on earth would anyone consider an ARM?" 

With his scenario, we're looking at a loan amount of $400,000 and a loan to value of 60% with excellent credit (scores are above 740).   I priced the following scenarios with zero points (origination or discount).   These rates are effective as of 5:00 p.m. December 15, 2010.

4.875% for a 30 year fixed (APR 5.020).  Principal and interest payment (P&I) = $2,117.   With this scenario, your principal and interest payment is never scheduled to change.

4.375% for a 10/1 ARM 12 month LIBOR with 5/2/5 CAPS 2.25 Margin (APR 5.731). P&I = $1997.    With this scenario, after 120 payments (10 years) the rate will adjust based on adding the 1 year (12 month) LIBOR is plus the 2.25 margin limited by the first "cap" of 5%.  The rate in 120 months cannot be higher than 9.375% nor lower than 2.25% (the margin also acts as "the floor" limiting how low the rate can adjust).  After the first adjustment, the rate will adjust once a year on that anniversary of the first adjustment limited by 2% up or down.  The highest the rate can be on this scenario during the lifetime of this loan is 9.375%. 

3.625% for a 7/1 ARM 12 month LIBOR with 5/2/5 CAPS 2.25 Margin (APR 5.742).  P&I = $1824.  With this scenario, after 84 payments (7 years) the rate will adjust based on adding the 1 year (12 month) LIBOR p the 2.25 margin limited by the first "cap" of 5%.  After 84 payments/months, the rate cannot go higher than 8.625% or lower than 2.25% (the margin/floor).  After the first adjustment the most the rate can adjust annually is 2% up or down following 12 the anniversary of the first adjustment (at 96 months) and annually thereafter.  For example, worse case at the second adjustment (96 months) the rate could be 10.625% (3.625% plus 5% at 7 years and plus an additional 2% at 8 years).

Selecting a 30 year fixed mortgage provides security of a fixed and options with your mortgage payment.  The home owner can pay additonal towards principal to pay down the mortgage.  A 15 year fixed mortgage is also more "safe" than an adjustable if you're concerned about retaining the mortgage beyond the ARM's fixed period.  However there is no flexibility with the payment (you can make a 15 year payment on a 30 year mortgage; you cannot make the 30 year payment on the 15). I'll admit I'm biased towards the 30 year fixed mortgage, however Americans currently still has a choice as to what mortgage options they prefer unless Congress changes this (as I'm afraid they'd like to).

Adjustable Rate Mortgages will reamortize based on the remaining term at their adjustment points.  For example, after 120 payments with a 10/1 ARM, the payment will be based on the new rate and a 20 year amortization.  With a 7/1 ARM, the payment will be based on the new rate and a 23 year amortization (7 years minus 30 years).

My client is actually considering an ARM because of the amount saved in monthly payments over the term he plans on retaining his mortgage.  

Let's compare the ARMs and 30 year fixed scenarios at 84 months…of course, there is no way for us to know what the LIBOR rate will be 7 years from now to predict an 100% accurate rate.

30 Year Fixed Rate at 7 Years.  Principal Balance = $350,879.  P&I=$2,117.  No change.

7/1 ARM at 7 Years.  Principal Balance = $341,250 providing a principal savings of $9,629 over the 30 year fixed rate.  The difference in payment between the 30 year and 7/1 ARM over this time period is $24,612 (2117 – 1824 = 293 per month.  293 x 84 = 24,612.  However…the payment is set to adjust.  Worse case scenario, the rate could go up to 8.625%.  Amoritzing $341,250 at 8.625% for 23 years provides a principal and interest payment of $2,156 – worse case scenario, this is only $39 more a month than what the 30 year fixed scenario has been paying the full 7 years.  

10/1 ARM at 10 Years has a principal balance remaining of $347,156.   The payment is $120 less per month than the 30 year fixed providing a monthly payment savings of $10,080.  And the 10/1 ARM will continue to have a fixed payment 3 years beyond the 7/1 ARM; at 7 years, the rate for the 10 year ARM is still 4.375% with the same principal and interest payment of $1997 where the 7/1 ARM payment at 85 months is unknown.

Bottom line, it's important to review your options and to consider your personal life plans.   A 30 year fixed rate mortgage if you're not planning on retaining that financing or home more than 10 years may be costly–however if you cannot stomach the thought of your rate ever adjusting, the 30 year fixed rate may be your cup of tea.  It is (and should remain) the homeowner's choice.

Filed Under: Adjustable Rate Mortgage (ARM)

Pricing a Home Affordable Refinance

July 1, 2010 by 1 Comment

Home Affordable Refinances allow home owners with conventional mortgages (Fannie Mae or Freddie Mac) who have had their homes depreciate refinance at competitive market rates.  

Factors that impact the mortgage interest rate are:

  • loan to value (new loan amount divided by the appraised value)
  • the lowest middle credit score of all borrowers on the loan
  • lock period and loan loan amount

A Seattle couple who purchased their home in 2005 for $400,000 with a 20% down payment with an interest only mortgage still has a loan balance of $320,000 if they have not made any additional payments towards principal.  This couple has excellent credit and is interested in refinancing but the big mystery is how much the home will appraise for since it's based on what other homes similar to theirs have recently sold and closed for.  

They currently make their mortgage payments to Chase and their mortgage is securitized by Freddie Mac, which means they probably qualify for the Freddie's Home Affordable Refinance Program:  Relief Refinance Mortgage.  With this mortgage, the loan amount is limited to current balance plus $5,000.   In order to limit the amount of cash possibly due at closing, I often price the rate at zero points to reduce closing costs.

Here's what current rates would look like based on different appraised values using a 30 year fixed rate priced with zero points (origination or discount):

Loan to value of up to 95%:  4.500% with 0 points (apr 4.571%).  This would be the same rate if the home has a loan to value of 80% (roughly $410,000).   Based on the Seattle couple's scenario, their home would need to appraise for $340,000 or more to qualify for this rate.

Loan to value over 95% and up to 97%:  4.625% with 0 points (apr 4.697%).  The home would need to appraise for around $335,000.

Loan to value over 97% and up to 105%:  4.750% with 0 points (apr 4.823%).  The home would need to appraise for at least $310,000.

Unless it seems real obvious to me what the homes appraised value may be, I tend to lock based on the worse case "possible scenario".  Once we receive the appraisal, we can adjust the rate accordingly.   If the appraisal comes in lower than the worse case "possible scenario", the home owner does have options, including bringing in cash to closing or terminating the refinance at the cost of the appraisal deposit.

Fannie Mae and Freddie Mac's Home Affordable Refinance program is helping many Washington state homeowners reduce their mortgage payments or convert their adjustable rate or interest only mortgage into a fully amortized mortgage.   This program is available for owner occupied, vacation homes and rental/investment property. 

Filed Under: Adjustable Rate Mortgage (ARM), Fannie, Freddie and FHFA, HARP - Home Affordable Refi, Refinance

Do ARMs Give You Goose Bumps?

June 30, 2009 by 2 Comments

Adjustable rate mortgages are becoming attractive once again for those who do notMortgageportergoosebumps plan on retaining their mortgage beyond the fixed period or who can stomach the unknown of what exactly their rate may be once the fixed period is over.

Today I quoted the following rates for a home buyer in Seattle with a 740+ mid-credit score who is buying a home with just over 20% down payment to have a loan amount at $417,000. 

30 Year Fixed:  5.125% with 1 point (APR 5.281%) Principal and interest payment of $2,270.51.

10/1 ARM:  4.625% with 1 point (APR 5.883%).  Principal and interest payment of $2,143.96. 

5/1 ARM: 4.125% with 1 point (APR 6.480%) Principal and interest payment of $2,020.99.

Let me begin by saying there is nothing wrong with a 30 year fixed rate in the low 5s.  In fact, historically speaking, it's a great rate.   What I'm most excited about is the return of the 10/1 ARM.   The 10/1 ARM offers a long term at a lower rate.  Based on this scenario, the monthly savings is $122.97.  Over a five year term, if you put that savings into a mattress; this is a savings of $7,378.20.  Use this amount to pay off non-tax preferred debt or to apply towards reducing the principal balance and it's even more beneficial.

Do factor how long you're planning on staying in your home and/or retaining the mortgage.  Remember that "life happens" and should you opt for a shorter period ARM, such as the 5/1 ARM, with intentions of moving–you may find yourself dealing with an adjustment that you were not planning on.   It's all about knowing what your options are, understanding your choices and the terms of the mortgage and making an informed decision.

 

Filed Under: Adjustable Rate Mortgage (ARM)

Reviewing an ARM Note for a Neighbor in West Seattle

January 27, 2009 by Leave a Comment

I've been working with a home owner in West Seattle who has an adjustable rate mortgage that she obtained almost five years ago from a big "local" bank.   She contacted me to obtain rate quotes for refinance because her ARM is set to adjust soon.   Here's what a review of her Note reveals:

The Note rate is 4.125% for five years with the first adjustment coming up on May 1, 2009.   The index is based on the 1 Year Treasury (CMT) and her margin is 2.75%. 

If her ARM were set to adjust today, her new rate would be based on adding the margin of 2.75% to the 1 Year Treasury rate of 0.49% rounded to the nearest 0.125% = 3.25%.  (Indices are changing dramatically in our current climate–it's hard to say where the CMT will be on May 2009).

This rate is amortized based on the remaining term of 25 years and every May her ARM will continue to adjust based on where the current index is (1 year Treasury – CMT) plus the margin of 2.75%.   This is also limited to specific caps that her Note features of 2% annually and a lifetime ceiling of 10.125%. 

Let's assume her rate adjust to 3.25% in May 2009.  The highest her rate could be on May 2010 is 5.25% and the lowest is 2.75% (the lowest the rate may ever be is limited to the margin of 2.75%).  If rates continuing rising, the worse case scenario would look like this:  May 2011 = 7.25%; May 2012 = 9.25%; May 2013 = 10.125% (because of the lifetime cap of 10.125%).

If worse case scenario, the CMT climbs dramatically over the next few months, the highest her rate could be is 6.125% based on her 2% rate caps.

Should this home owner refinance with her adjustment date looming near?  It really depends on what her personal financial plans are and if she can tolerate having her rate change annually.  Her main risk is where rates may be in the future.   The choice is hers.

What would you do?

Are you a Seattle area home owner with an ARM?  I'm happy to review your Note for you–no refinance required.

 

Filed Under: Adjustable Rate Mortgage (ARM), Refinance

Gimme Five! Comparing Today’s 5 Year ARM to a 30 Year Fixed

May 24, 2008 by Leave a Comment

Highfive

There is currently about a 0.75% difference in rate between the conforming 30 year fixed and 5/1 ARM and 0.625% in rate with conforming-jumbo loans.  Is that enough for you to opt for an adjustable rate mortgage?

Beyond the obvious question: "how long do you plan on retaining the mortgage or staying in your home?"   Here are some other stats to consider based on rates I quoted Friday morning using a purchase of $500,000 with a loan amount of $400,000.   The closing costs on both loans are identical.

30 year fixed at 5.75% (APR 5.902%) has a principal and interest payment of $2,334.

5/1 ARM at 5.000% (APR 6.759%) has a principal and interest payment of $2,147.  This is a monthly savings of $187.

The 5/1 ARM is fixed for 60 months and will then the rate is re-calculated.   The 5/1 used in this scenario is a 5/1 LIBOR with a margin of 2.25% and caps of 5/2/5.   For now, lets review your savings over the 60 month period.

The 5/1 ARM will save $11,220 over the 30 year in five years in payment alone. 

30 year fixed at 5 years has paid $28,951 towards principal and has an estimated balance of $371,049.   $111,106 has been paid towards interest (no benefit towards your prinicpal, however it may be a tax benefit).

5/1 ARM at 60 months has paid $32,663 towards principal and has an estimated remaining balance of $367,337.   $96,228 has been paid towards interest.

Over a five year period, the net (interest) savings of the 5/1 ARM over the 30 year fixed assuming you do not make any additional payments towards principal is $14,878.

So what happens if someone decides to select a 5/1 ARM and 60 months later, they’re keeping the home?  They can refinance or not based on what the current market and what their finacial plans are.  The monthly savings over 60 months is plenty to cover the typical cost of a refinance ($2000-$2500) assuming rates are not favorable enough to opt for a "no cost refi".

If you decide to retain the mortgage, you will add the margin of 2.25% to the current 1 Year LIBOR rate when your mortgage is adusting.  (As of today, the 1 Year LIBOR is around 3.067%).   Your mortgage is reamortized based on the remaining term (25 years at the first adjustment).   The caps with this particular ARM are 5/2/5 meaning that the highest your rate can adjust is to a steep 10% and the lowest your rate will be at the first adjustment is 2.25%.   That’s a huge range and whatever your rate will be depends entirely on LIBOR.   Some 5 year ARMS offer caps of 2/2/6 which would limit the first adjustment to 2%–the initial rate is typically slightly higher.   Do learn exactly what your cap, margin and index are before you accept any adjustable rate mortgage.

I suggest considering the following:

What is your risk tolerance?  Will having a mortgage with the potential to adjust in 5 years give you a rash or cause you to lose sleep at night? 

How long do you plan on staying in the home or retaining the mortgage?  If you have a tendancy to refinance when rates improve or if this is a home (such as a starter home) where you may not keep it for 5 years, you may want to consider the ARM. 

Picture your life and where you and your family may be five years from now.   Is your income stable or growing?  Do you have retirement in your sights?

How disiplined are you?  $187 per month could make an impact on paying off non-tax preferred debt, paying down principal or building your savings.  Pay yourself the $187 per month in an interest bearing account at 3% and you’ll have $12,000 more in 60 months in addition to the other savings.

Regardless of what program you select for your mortgage…the choice is yours and it is your responsibility to learn as much as you can about the program–ask questions! 

Do you have an existing mortgage you’re unsure of?  Has your loan originator left the mortgage industry?  I’m happy to help Washington State home owners with their mortgage needs–including reviewing your existing financing, such as ARMS.  My mortgage adoption program does not require any refinancing or new mortgage.

Filed Under: Adjustable Rate Mortgage (ARM), Financial Planning, Mortgage, Residential Purchase

I Love Checking Out ARMs: Reviewing An Existing Mortgage

April 15, 2008 by 1 Comment

Recently a friend approached me confessing to having one of those "awful adjustable mortgages"…she thinks she needs to refinance and take advantage of today’s lower rates.   Before assuming that someone "needs" to refinance, I like to review their current mortgage and what their financial goals are.  Sometimes, people do not need to refinance…they just need to understand their mortgage terms.

Current Mortgage:  P&I Payment $3,330 (original balance $520,000).

  • 7/1 Adjustable Rate Mortgage: Note Rate 6.625%
  • Caps: 2/2/5
  • Margin: 2.25
  • Index: 1 Year LIBOR (currently 2.637% as of this the date of this post).

There is approx. 65 months remaining with the fixed period rate of 6.625% before the mortgage adjusts.   When the mortgage adjusts, the new rate will be 2.25% plus the current 1 year LIBOR rate EXCEPT the rate will be no lower than 4.625% and no higher than 8.625% due to the 2% adjustment cap. 

Best case scenario at first adjustment date with current mortgage:

Rate: 4.625% with principal and interest payments for 12 months of $2,780.   Note: If the mortgage was adjusting today, the rate would be closer to the best case scenario at 4.875% (2.25% plus 2.637% = 4.887% rounded to the nearest 0.125%).  Alas…they have 65 more months before knowing what the going rate for the 1 Year LIBOR will be.

Worse case scenario at first adjustment date with current mortgage:

Rate:  8.625% with principal and interest payments for 12 months of $3,937.

Possible scenarios that I suggested:

Refinancing into a conforming-jumbo mortgage 30 year fixed at 6.375%.  This would provide a principal and interest payment of $3,232.   With closing costs at $2900, they will break even on this scenario in 30 months.  From 30 months (the break even point) to when the fixed period of the ARM is over, the savings based on the monthly payment would be $3430.

Restructuring the existing mortgage into two mortgages with a conforming first at $417,000 at 5.875% and second mortgage paying off the balance (they can opt for a fixed second or a HELOC).   With a principal and interest payments of $3,194 and closing costs of $3,200; it will take 24 months to break even on this scenario.   From 24 months to when the fixed period of the ARM is over, the savings based on the difference between the monthly payments would be $5,576. 

LiborcompThis chart, which I created utilizing The Mortgage Coach, is factoring in the 2.25% margin to the LIBOR rate back to January 1999.  You can see there is a significant range with the rate.   Home owners with ARMs based on the LIBOR rate from 2002 to 2004 were probably grinning from ear to ear (depending on what their margin was) when you see what their rate was compared to the 30 year fixed.  Timing is everything with an adjustable rate mortgage.

What ever the home owner decides to do is completely up to them.  Of course one of their options is to not refinance and wait to see what the new rate (LIBOR) will be in 65 months.   If they wound up with a "best case scenario" new payment, it would be pretty sweet however the cost of paying the higher payment for 65 month and we don’t know what the index will be at the date of adjustment.    Understanding your mortgage and knowing your available options just starts with contacting your local Mortgage Professional. 

By the way, if you are a Washington State  home owner who has not heard from your loan originator lately or if you would like me to adopt your mortgage, please contact me.   Many LO’s have left the industry or do not provide service once the loan has closed.  I’m happy to review your ARM (or fixed rate mortgage) without any obligation to refinance. 

Filed Under: Adjustable Rate Mortgage (ARM), Jumbo/Non-Conforming, Refinance

Not a Friend of this Family: Part 2

March 31, 2008 by Leave a Comment

In part one of this story about Michael and Pam investigating a refinance with Woo Who, we uncovered how the bank Loan Officer was not willing to provide a copy of the Federal Truth in Lending to Michael and Pam.   It was not until after Michael insisted that it was his right to receive this document, that it appeared disclosing a prepayment penalty that he was not informed of. 

The story gets better.  As I mentioned, Michael and Pam’s existing adjustable rate mortgage is scheduled to adjust this June.  I reviewed the Note with Michael showing him that the index his mortgage rate is tied to is the Monthly Treasury Average (MTA).  The Monthly Treasury Average is just that: a 12 month average of the monthly average yields of the US Treasury securities.  The 12 month average is determined by adding together the Monthly Yields for the most recently available twelve months and dividing by 12. As it is based on a 12 month average, the rate does not move drastically.  This could act as a benefit when rates are moving upwards and is less beneficially when rates are dropping.   Here is the 411 on Michael and Pam’s current loan:

  • 5/1 Adjustable Rate Mortgage current rate 5.125%.  Principal and interest payment of $1154.31.
  • 1st adjustment on June 1, 2008.  Adjusting annually thereafter. 
  • Index: Monthly Treasury Average – projected value on June 2008: 2.948%
  • Margin: 2.600%
  • Lifetime Cap:  11.950%

Based on this information, their new rate is estimated at 5.548%.  The new rate is rounded up to the nearest 0.125% = 5.625%.   The new mortgage would reamortize at their balance at that time (estimated at $196,000) based on the remaining term providing Michael and Pam a principal and interest payment of $1218.29.   This is without refinancing–no closing costs–no loan approval.  Simple.

Woo Whoo’s proposal is a 5/1 ARM with a prepayment penalty at 5.375% with a principal and interest payment of $1108.74 and closing costs of $2283.74 (not calculating how many years and what the penalty is for the prepay).

When Michael and Pam understood their options, they elected to stick it through with their existing ARM.  Their rate should drop lower when it adjusts again next June.   Michael was puzzled (to put it mildly) as to why the representative from Woo Whoo Bank didn’t explain this to them.  Especially since the loan that would be refinanced was with Woo Whoo.   

It’s painfully simple.  The Loan Originator would not be paid for giving free advice.  It’s real easy for LO’s and mortgage companies to target those with adjustable rate mortgages and plant fear of the adjustment.  Or perhaps the Whoo Who Loan Originator didn’t even consider how Michael and Pam would fair not refinancing.   

This is why it’s so important to review your mortgage Note and understand how and when it adjusts (if you have an ARM).  If it all seems like too much to figure out, contact your Mortgage Professional to help you.  If your loan originator is neglecting you (perhaps they’ve left the industry or do not care for clients after the transaction is closed), I’m happy to adopt your Washington State mortgage…no refinance required.

It’s all about understanding all of your options and sometimes, that option is: do nothing.

Filed Under: Adjustable Rate Mortgage (ARM), Mortgage, Refinance

Not a Friend to this Family: Part 1

March 28, 2008 by Leave a Comment

When I helped Micheal and Pam with the financing of their home almost five years ago, it was a challenging transaction.  They were excellent borrowers, except for the particular type of Visa he had (they’re Canadian).   Long story short, we wound up doing a 5/1 ARM through Woo Whoo Bank as they were only planning on staying here for about 5 years.  About four months ago, Micheal met with me to review his Note and to see about refinancing.  They may be staying a few years longer if they have their choice…Michael is having a challenge extending his Visa.  Michael wanted to refinance and was concerned about his ARM adjusting.  With our current mortgage climate and his current situation with his Visa, I could not refinance him.   We reviewed how his ARM and discussed how it functions and at that time, I told him that he has time–he did not to refinance yet.  He was still feeling pressured to do something–letting his ARM adjust was not sinking in.  He went directly to Woo Whoo to investigate a refinance.  Michael forwarded me the first good faith estimate from Big Bank.  The rate seemed too high to me; especially compared to his current mortgage.   I again encouraged him to wait out a few more months to see what rates do and that by that time,he would have more information on the status of his Visa.  Fast forward to the present.

[Read more…]

Filed Under: Adjustable Rate Mortgage (ARM), Interest Rates, Rant, Refinance
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