As home prices started to soar about five years ago, many buyers took advantage of low-rate ARMs just to get a foot in the door. At the same time, mortgage rates were flirting with historic lows, and lenders began offering more interest-only loans and option ARMs, which allow borrowers to make low minimum payments. While many borrowers said they'd take the lower interest rate and put the money aside to offset higher payments later, most didn't.

ARMs accounted for just 22% of mortgage originations last year. But in 2004 and 2005, ARMs accounted for about a third of home loans. The short-term indexes to which ARMs are tied have moved up sharply as the Federal Reserve has tightened credit. Of the ARMs due to reset this year, half will be refinanced, predicts the Mortgage Bankers Association. The coming wave of adjustments has been described by some as an "ARM tsunami. 

Adjustment blues. If you have an ARM, get out the life raft and start preparing... "What should I do with my ARM?" is the most common question these days. To find the answer, start by pulling out the contract you got at settlement.

To calculate the rate on your loan when it adjusts, you need to know the index your ARM is based on (such as the one-year Treasury, 11th District COFI or LIBOR), the current rate on the index and the margin that's added to get your full rate. The only information your contract won't contain is the latest index rate, but you can get it for the most popular ARM indexes from HSH Associates Financial Publishers (hsh.com). One bright spot: Most ARMs have an annual cap, often two percentage points.

When you have the skinny on your loan plus your latest balance, you can estimate your new payments. Say you took out a 5/1 ARM in late 2002 at 5.2% for $240,000. (A 5/1 ARM has a fixed rate for five years, then converts to a one-year ARM.) Your current principal-and-interest payment is $1,318. At the end of this year, assuming an annual cap of two percentage points, your rate would jump to 7.2%, upping your monthly payment to $1,588 on the remaining $220,647 loan balance.

Should you refinance?  If you're planning to sell soon after your adjustment, refinancing may not be worth the cost and headaches. But if you're planning to stay in your home for a while, you'd be wise to lock in a fixed rate now.

Fixed rates are still fairly low -- recently 6.3% on 30-year mortgages -- and they should remain below 6.5% for the rest of the year. With rates for 5/1, 3/1 and one-year ARMs all hovering around 6%, the difference is minuscule.

If you refinanced to a 30-year fixed mortgage at 6.3% on the $220,647 loan in the example above, your monthly payment would be only $1,370, assuming you don't finance closing costs. (Expect to pay 2% to 4% of the loan amount in closing costs, or $4,000 to $8,000 on a $200,000 loan.) Ask your mortgage consultant to help you determine whether refinancing your ARM with a fixed-rate loan makes sense based on how long you plan to stay in your home.

Some borrowers who bought at the peak of the market with interest-only and option ARMs -- who have little, if any, equity in their homes -- could have trouble qualifying for the higher payments of a fixed-rate mortgage. That's especially true as lenders begin to tighten their standards. Another roadblock to refinancing is prepayment penalties. Last year, 84% of option ARMs carried a prepayment penalty that could force borrowers to come up with thousands of dollars if they decide to refinance within the first few years of their loan. 

My best suggestion is... call me (646)294-2561 or email me ProRealtor@verizon.net to analyze your situation and pinpoint where we can help you. At that point I will do a Highest Price Analysis on your home and determine what the best solution is for you. We'll discuss all of your options FREE of charge and under no obligation.

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