Better News for ARM Borrowers

In addition to the subprime borrowers and other homeowners with toxic loans, there has been a great deal of concern expressed about the potential damage to the economy due to resetting of other types of ARMs. This concern was well warranted back in 2007 when the index values that these loans were tied were all high.

But recent action by the Federal Reserve has lowered short-term rates and that means the index values that ARMs are tied to have dropped too.

Here are a couple of examples:

Example #1 - A 5/1 ARM tied to 1-year Constant Maturity Index (CMT) with a margin of 2.75%

During most of 2007, this index was about 5% so if you were to add the margin of 2.75, you would end up with an interest rate of 7.75%. If a borrower's initial ARM rate was 5%, you can see that he would be in for a big increase. On a $300,000 loan at 5%, the payment would be $1,610 but would increase upon adjustment to 7.75% it would rise to $2,080, an increase of about 30%.

Today, however, the CMT is only 1.54% so adding 2.75% and (likely) rounding up to the next .125% yields 4.375%.  In other words, both the rate and the payment would actually go down to $1,511. 

Example #2 - A 3/1 ARM tied to 6-month LIBOR with a margin of 2.25%.

This index was about 5.5% most of last year so when a LIBOR loan would have reset, it would have gone to 7.75% too. The payment would have increased in the same way the CMT loan payment did.

Today, LIBOR is not as low as the CMT index, but it is about 3%. That means that a LIBOR ARM would reset to 3% + 2.25% = 5.25%.  That would mean a very small adjustment to the borrower whose loan started at 5%.

Strangely, even with this good news, the media are still talking about another million homeowners facing foreclosure due to their ARM loan resetting. 

That doesn't mean that there aren't many, perhaps a million, homeowners whose loan balance is higher than the current value of their properties, but at least if they have an ARM like these, they will still be able to afford the payment and won't lose their homes.

It also doesn't mean that ARM borrowers who have enough equity and the intention of staying in their homes for a long while shouldn't consider a refinance into a long-term fixed rate mortgage. They probably should. But I know one problem and that is that some people whose loan will adjust down, let's say to 4.25%, will look at a 30-year loan at 5.5% and see that the payment will go up somewhat.

Some of these people will be tempted to wait. Bad decision! They will think that they can out-guess the market and refinance just before rates move up. Not a smart move because no one, especially amateurs, can make that call successfully.

The benefit of a refinance will come down the road when interest rates inevitably move higher. That is the purpose of long-term rate PROTECTION.  [Emphasis added on purpose.] 

So if you have an ARM, get out your loan documents and acquaint yourself with the terms so you know what is going to happen to you. They make a plan and execute it.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.