Is your home loan an adjustable rate mortgage?
Have you been putting off your refinance?
It may be time to start thinking about converting your adjustable rate mortgage into a fixed rate.
Here’s why: rates are on the rise. If your ARM is about to start adjusting, or already is, its interest rate may be primed to shoot upward.
When an ARM hits its adjustable period, its interest rate is no longer fixed, but goes up and down based on an index and margin. (For an in-depth look at how ARMs work, read more here.) The index is based on the current cost of money, which, for the past few years, has been almost nothing. ARMs that have entered into their adjustable period have been dirt cheap. But as the economy improves, that could change.
We’ve already seen an uptick in mortgage interest rates since May. As of May 2013, the average 30 year fixed rate was 3.54% according to Freddie Mac. Now it’s at 4.40%.
As interest rates of all kinds increase, so will the rate on your ARM, after your initial fixed period. You should ask yourself, “What will rates be like when my fixed period is over?”
Let’s look at the history of some popular ARM indexes. It’s important to check your mortgage note – the document that shows your mortgage specifics – to know for sure which index your ARM is based on. Past index interest rate levels are a good indication of where they may be in the future.
ARM Index History
CMT Index: Many ARMs are based on the 1-year CMT. The CMT is also known as the 1-year Treasury Security or 1-year T-Bill, and is based on U.S. Treasury bond yields. This index moves faster than the other major ARM indexes, so your rate could move up quickly if you have a CMT ARM.
CMT Index history: Currently, the CMT is at 0.12%. So an adjusting ARM with a margin of 2.5% would have a rate of only 2.62%. However, in July 2007, the CMT was at 5.04%. So the same loan would be at 7.54%. And there’s nothing stopping the rate from going that high again.
MTA Index: This index moves up and down more slowly than the CMT, since it’s based on the previous 12-month average of the CMT. If you have an ARM loan based on this index, you may have more time to refinance, since its rate won’t shoot up quickly.
MTA Index history: In June 2007, the MTA hit 5.01%, so an adjusting ARM with a 2.5% margin would have a full rate of 7.51%. Currently, the MTA is at 0.15%.
LIBOR Index: LIBOR stands for London Inter-Bank Offering Rate and is based on the cost of funds traded between banks in London. It is meant to follow world economic conditions. This index has been increasingly popular for ARMs in recent years.
LIBOR Index history: The 6-month LIBOR is the most common LIBOR index that ARM loans use. At the moment, the 6-month LIBOR is at 0.40%, but as recently as September 2007, it hit 5.35%. An ARM with a margin of 2.5% would be at 2.9% today, but 7.85% in 2007. And it could head that direction again.
ARMs Can Be Useful, But…
Because no one can predict the future, an ARM loan will always be a risk. Yes, they can offer you a very low initial rate, sometimes in the 2’s and 3’s, but they can shoot up to the 8’s and 9’s once that initial fixed period is over.
Many people get an adjustable rate mortgage because they figure they will refinance out of it, or sell the home before the rate shoots up. This strategy pays off sometimes, but it can backfire.
Right now may the ideal time to refinance your ARM into a fixed loan. Rates are primed and ready to rise, but fixed rate mortgage interest rates are still low.
If there’s any chance you could own your property or keep the mortgage longer than you first anticipated, it’s a great time to contact a loan professional who can walk you through a fixed rate refinance.