Tough Times Series: What to Do When Your ARM Is Due
by Dianne Molvig
If you have an adjustable-rate mortgage (ARM) and your fixed-rate period is drawing to an end, your first rate adjustment is looming. It's time to devise a plan.
Many ARM borrowers are facing that task with uncertainty. One of three homeowners with ARMs say they don't know what they'll do when their rate adjusts, according to a March 2007 Bankrate.com survey. If you're among those who feel unsure, consider a few pointers.
Take stock
Begin by closely examining the ARM you have. How often can the rate adjust? How much can it rise at each adjustment? How much will your monthly payment increase at each adjustment? What's the limit on the rate increase over the life of the loan?
"The first thing you have to do is know where you're at," says Roy Loo, loan originator at Arrowhead Credit Union, San Bernardino, Calif. These days, many Arrowhead members are asking Loo for help in analyzing their ARM contracts. Many got their ARMs elsewhere, sometimes from mortgage brokers who glossed over the details when issuing the loan. Those borrowers end up poorly informed about the ARMs they hold.
One of three homeowners with ARMs say they don't know what they'll do when their rate adjusts.
In fact, the above-mentioned Bankrate.com survey found that 34% of homeowners didn't even know what type of mortgage they owned, much less the loan details.
That statistic doesn't surprise Loo. He's seen too many borrowers who grab the smallest initial monthly payment possible, without considering the big picture. "They jump into a mortgage blindly," he says. "They buy a mortgage payment [not a mortgage], and now they're paying the price" as they face rising house payments.
The upshot is that if your ARM is coming due, you first need to fully understand what that ARM is. Loo advises talking to a loan professional at your credit union, whether or not you got the ARM there. He or she can help you understand your ARM and decide what to do next, based on your individual circumstances. "Talk to someone who has your best interests at heart," Loo says, "and who can help you come up with a game plan."
Weigh your choices
If your ARM is coming due for adjustment, you have three basic options:
If your ARM is coming due, you first need to fully understand what that ARM is.
- Refinance into a fixed-rate 30-year (or shorter term) mortgage.
- Refinance into a new ARM that has terms better suited to your situation.
- Stay with the ARM you have now and take the rate adjustment.
Refinancing into a fixed-rate mortgage means you'll never have to worry about rate adjustments again for as long as you live in your home. But usually the interest rate on a fixed-rate loan is higher than for an ARM, although as of mid-2007 the gap between fixed and ARM rates was slim.
Another possible obstacle to refinancing into a new mortgage is closing costs, which usually run 2% to 4% of the mortgage amount. A $200,000 mortgage, for example, could have closing costs of at least $4,000. What's more, your current ARM may have prepayment penalties, which can be several thousands of dollars. Check your contract.
Still, it may be worth spending the money to refinance to a fixed rate if you plan to stay in your house long enough to recoup the costs, says John Theobald, mortgage loan originator at Wright-Patt Credit Union, Fairborn, Ohio. As a general guideline, your length of stay "should be at least three to five years," he advises. But that will depend on exactly what your closing costs and any prepayment penalties add up to.
It may be worth spending the money to refinance to a fixed rate if you plan to stay in your house for at least three to five years.
Another option is to switch to a new ARM with better terms than the one you have. You'll face the decision again in a few years about what to do when the rate adjustment hits. A new ARM might be a viable option for a borrower who plans to sell the house in a couple of years. In the meantime, you'd save a bit on the monthly payment. But again, factor in closing costs and any prepayment penalties.
Staying put
Finally, you could keep your current ARM and take the adjusted rate. Theobald points to the example of a 3/3 ARM, with an initial fixed rate for three years, and a rate adjustment every three years. "If you got in at 4.125% three years ago and it's only going to adjust a maximum of two percentage points," he says, "you may want to ride out that 6.125% for another three years and see what happens."
Staying in your current ARM may make sense if you plan to sell your house soon.
That buys you some time to see what interest rates do, which, of course, is anyone's guess. You'd have to be willing to take your chances and live with the uncertainty.
"The other thing to consider is how long you want to be in that house," Theobald adds. "If you're in a 3/3 ARM and you plan to sell within 24 to 36 months, it would make sense" to remain in your current ARM.
Unfortunately, some homeowners with ARMs coming due can't afford the refinancing costs on a new mortgage or the higher payments a rate adjustment will trigger on their current ARM. These homeowners feel stuck, and selling their home may seem the only way out.
For them, Theobald echoes Loo's earlier suggestion: Talk to people at your credit union, whether you're looking for loan advice or help with budgeting so you can afford your mortgage. "Keeping your home is important," Theobald emphasizes. "The last thing that should go is your home."
Published September 3, 2007
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