Adjustable Rate Mortgages – New Interest Rate Strategy
Adjustable Rate Mortgages – New Interest Rate Strategy. Over the last few years, many people squeezed into new homes using adjustable rate mortgages. With interest rates going up, you now need a new interest rate strategy.
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Adjustable Rate Mortgages: Buyer Beware
Remember when your mom told you that if it sounds too good to be true, it probably is? The same could be said about Adjustable Rate Mortgages (or ARM in industry lingo). These guys can be a wolf dressed in sheep's clothing and if you aren't careful they are going to huff and puff and take your home away!
An Adjustable Rate Mortgage works like this. Initially, you are probably going to be paying anywhere from 2 - 3 % below the current market interest rates on your mortage. For many people, this allows them to buy a bigger house, one that would normally be outside their price range. The normal reasoning is that by the time the loan adjusts - which could be a year from now, or as much as 7 - 10 years from now - they will be earning more, the economy will be better, etc.
The problem they run into is that as good as we hope the future is - sometimes it isn't. Lives change, the economy fumbles or we change jobs. Suddenly, we went from two incomes to one or we just aren't making as much as we were a few years back. Even worse, interest rates rise and when it comes time for our ARM to adjust it goes up - way up.
Adjustable Rate Mortgages – New Interest Rate Strategy. Some ARM's adjust every year and are based off current interest rates set by the Federal Reserve. Sometimes, this can be a good thing as interest rates may have fallen and you could end up paying in interest than you were at the start of your loan. However, as is most often the case, the exact opposite is true - interest rates have risen, and you end up paying more each month. The budget starts to get stretched a little thinner.
There are other ARM's that adjust after a specified number of years - say 7 to 10. When they finally kick it, it can be a real sticker shock for the homeowner. If they haven't planned for this financially it could mean the difference between them keeping or losing their home. In some cases, monthly mortgage payments could double in size depending on how low your interest rate was before the adjustment and what current interest rates are.
So what's the smart move for most home owners? Stick with traditional mortgages that have a predefined interest rate that is locked in over the life of the loan. If market conditions warrant sometime down the road, you can always look into refinancing your mortgage and getting a lower interest rate.
Adjustable rate mortgages are good for those who like to gamble - and some argue they are good for families just starting out who know they will need a bigger house in the future and will have larger incomes in the future as well. However, as we all know, nothing is as certain in life as change and sometimes the smart homeowner knows when to play it safe and keep a roof over his or her head!
Adjustable Rate Mortgages – New Interest Rate Strategy
Over the last few years, many people squeezed into new homes using adjustable rate mortgages. With interest rates going up, you now need a new interest rate strategy
01. Adjustable Rate Mortgages – ARMs
Adjustable rate mortgages carry a bit of a gamble for home owners. Essentially, you trade smaller interest rates and lower initial payments on the gamble rates will not increase over time. If rates stay low, you make out like a bandit. If rates increase, you need to consider your options to avoid getting stuck with a high interest rate loan and resulting cash flow problems from increased monthly mortgage payments.
For the last three or four years, adjustable rate mortgages have been offered with incredibly low interest rates. Many people used these low, low, low rates to buy homes that would otherwise be beyond their means.
Starting in 2004, Federal Reserve Chairman Alan Greenspan started making noises about increasing money borrowing rates. He has followed through on these hints.
Although mortgage rates aren’t tied directly to the Federal Reserve Bank, they are heavily influenced by it. As a result, many people are now facing tight finances.
02. Avoid Rising Rates
There are really only two solutions for avoiding the increase in interest rates on adjustable rate mortgages. The first strategy is to immediately convert to a fixed rate mortgage product. Fixed rates are still at historic lows when compared to rates offered over the last 50 years.
By flipping to a fixed rate, you will be able to solidify your budget and finances since you will know exactly what you have to pay each month. If rates decrease in the future, you can always try to flip back to an adjustable mortgage loan.
Unfortunately, some home owners are simply going to have to face the fact they lost one the interest rate gamble. Typically, this will occur when you realize you simply can’t afford to make the monthly payments required by getting a fixed rate loan. In such a situation, you are going to have to sell your home and downsize.
In most situations, it is better to do this now since you’ve probably built up a sizeable chunk of equity over the last few years and want to avoid a loss of that equity as the market cools down. While this may sound like a disaster, it really isn’t. Yes, you have to downsize, but you should still have built up a chunk of equity.
Adjustable Rate Mortgages – New Interest Rate Strategy. Interest rates are going up whether you want to acknowledge it or not. The time to deal with your adjustable rate mortgage is now, not when you straining to make payments.
Adjustable Rate Mortgages – Determining Rates
Adjustable Rate Mortgages – New Interest Rate Strategy. Adjustable rate mortgages are to home buyers as carrots are to bunnies – very tempting. The secret to figuring out if an adjustable rate mortgage is a good deal is the rate index used.
01. Indexes – Setting Rates
Lenders really want your business and are willing to create enticing loan products to get it. Occasionally, lenders will offer adjustable rate mortgages that offer a lot of carrot on the front end, but none on the back end.
These loans are typically offered to you with an insanely low initial interest rate, which has you looking at mansions and other structures completely out of your realistic price range. The problem with these loans is the rate rises dramatically after six months or a year when the rate becomes pegged to an index.
Indexes are a unique animal when it comes to the mortgage industry. An index is a calculation of general interest rates charged across a number of financial markets that a bank uses to set a real interest rate on your loan.
Common financial markets or products considered in this index include six month certificate deposit rates at local banks, LIBOR, T-Bills and so on. Let’s take a closer look.
Certificate Deposits – Better known as “CDs”, these are the fixed time period investing vehicles you can get at your local bank. You agree to deposit a certain amount for six months and the bank gives you a guaranteed interest rate of return such as three percent.
T-Bills – Officially known as Treasury Bills, T-Bills are the credit cards for the federal government. Currently, Uncle Sam owes trillions of dollars on his and pays a certain interest rate on the debit. The interest rate is used by lenders in calculating your ARM rates.
Cost of Funds Index – It gets a bit technical, but this index represents the rates being used by banks in Nevada, Arizona and California as an average.
LIBOR – Officially known as the London Interbank Offered Rate Index, LIBOR is a popular index upon which to base ARM rates. Now, you are probably wondering what London has to do with the United States real estate market. LIBOR represents the interest rate international banks charge to borrow U.S. dollars on the London currency markets. LIBOR rates move quickly and can result in unstable interest rate moves for your adjustable mortgage.
02. Why Indexes Matter
Indexes matter because they set the base of the interest rates charged on your loan. Assume you apply for an adjustable rate mortgage based on a LIBOR index. Assume the LIBOR rate is 2.2 percent when you apply. The 2.2 percent is your starting interest rate. If the LIBOR shoots up one percent in eight months, your loan will do the same.
Adjustable Rate Mortgages – New Interest Rate Strategy. Importantly, the index rate used for your loan is not the interest rate you will pay. Instead, you have to add the banks margin on top of the index rate. Most banks will charge two to three percent on top of the index rate.
Using our LIBOR example, the initial interest rate of your loan would be 2.2 percent plus whatever the bank is using as a spread. Obviously, this means you need to closely read the loan documents to figure out how the game is being played!
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