ARMs keep getting riskier as time passes by

The Federal Reserve has raised short-term rates therefore reducing the savings on interest-payments when comparing adjustable-rate mortgages to fixed-rate mortgages.

The Federal Reserve raised short-term interest rates at each of their meetings during last year (2005). First-year rates on 1-year ARMs rose a full percentage point over the year while 30-year fixed-rate loans were only up about one-half of a percentage point.

These actions and the future outlook on interest rates as well as the housing market will put many homeowners in trouble when their fixed rate term on their ARM and interest-only ARM period ends. The monthly payment is likely to jump by 20%, 30% or even 40%.

The good news: You can still get a good deal refinancing to a 15, 30 or 40 year fixed-rate mortgage, thanks to the bond market, which has defied the Federal Reserve and kept long terms rates at a steadier pace than short-term rates.

If you are among the millions (I am one of them) who took out an adjustable-rate mortgage in the past few years, now it’s time to either get a 15, 30, 40 year fixed-rate mortgage or a Hybrid ARM with a longer fixed-rate term (5-7-10 years). Figure how much you can save per month by refinancing. If you’d have the new loan long enough for that saving to offset the refinancing costs, do it. Remember the Federal Reserve probably is not finished raising short-term rates so your ARM could end up being a lot higher than it is now. If you refinance then to a fixed-rate loan, these rates could be higher as well.

The people that are at most risk than the people with soon to end hybrid ARM or interest-only ARM are those people that were enticed to take out an negative amortization ARM loan, most commonly known as “Option ARM” where they make minimum payments of 1% or less. The rise on short-term interest rates and most importantly the housing market direction could really leave them with out a home.

Another way, for people with ARM loans, to tackle this problem is by making a big principal payment, reducing the size of the loan. This will cut the monthly payments when the loan adjusts. ARMs are figured by applying the new interest rate when it adjusts to the remaining loan balance and term.

Homeowners often overlook this possibility because we are more familiar with fixed-rate loans. In a fixed-rate loan if you make a big principal payment, your monthly payments do not get reduced, it will however help you pay-off the loan faster.

Of these two options I mentioned, refinancing or making a big principal payment, refinancing is probably better because it means locking in a relatively low fixed rate. If you pay down the principal, you will reduce your monthly payments but you would still face the risk of higher payments if interest rates continue going up.

January 5th, 2006 · Filed Under Mortgage - Loan Information

Comments

2 Responses to “ARMs keep getting riskier as time passes by”

  1. Barbara Jerde on October 12th, 2009 12:33 PM

    I want to refinance from an ARM. I contacted Freddie Mac earlier and I found a website that listed loan servicers that could give me a fixed rate loan and not have to pay MIP insurance since I paid 20% down when i originally bought my home so I would not have to pay MIP insurance. I can do this through my present mortgagor but I want to do it locally. Where do I find a list of the loan providers that can offer this Freddie Mac program please?

  2. Ney on October 13th, 2009 7:45 AM

    Barbara Jerde,

    I believe what you are looking for is an FHA loan. FHA loans don’t require MIP because it is already built into the loan. Here is the link if you would like to find a local FHA approved broker or lender.

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