(photo from http://www.dogspunk.com/)
Talk on the town is that millions of people have an initial period fixed rate ARM on which the fixed rate period is about to end. Lenders are gearing up with direct mail campaigns to flood junk mail into your mail box with the purpose of cajoling you, scaring you or otherwise motivating you to get rid of that ARM right now!!!
But should you?
Walk through these 5 steps with me and protect yourself from needless refinancing proposals.
1) Go get the package of paperwork you signed when you took out your last loan/bought the house. This is KEY! How can you compare anything new if you don't know what you have already? Then find the information to fill out the following questions:
- What is the index? ________________________
- What is the margin? _______________________
- What is the Periodic Cap? __________________
- What is the Lifetime Cap? __________________
- What is the date of first adjustment? ________
The date of first adjustment is when you will no longer have your loan payments based on the fixed interest rate you have had up to this point. But what is the rate going to be?
2) Calculate what the interest rate is going to be. Visit mortgage-x to see what the current rate is for every index out there. Find your index and input the value below:
- Currently my index is at _________________
Add the margin to the index
- My Margin + Index is currently at ______________
Now you know where your rate will be set for the next year. If the increase seems extremely high, make sure you take into account the "caps" on your loan. The way you do this is take your margin + index rate and subtract your current fixed interest rate. How much was the change? Is that more or less than the "periodic cap" or the "lifetime cap" you looked up in step 1? If the change was greater than either cap, your rate is only going up by the capped amount. For example, say your index + margin is 7.50% and your fixed rate loan is at 5.00%. That is an increase of 2.50%. However, if your periodic cap is set at 2.00% then your loan rate could only go up by that amount (2.00% + 5.00% = 7.00%). If you have more questions call me (972-765-4005).
3) Calculate the cost of doing nothing. That's right, figure out what it would cost for the next year to leave everything as-is. Visit this simple mortgage calculator here and insert your balance, the new interest rate (margin + index) and then multiply the payment amount by 12 to get the amount you will pay for the next year.
- By doing nothing my loan will cost _______________ for the next year
4) Estimate that closing costs on a refinance are equal to 3% of the amount you borrow or $3,000 whichever number is greater. Input that amount here:
- By refinancing I will spend approximately _________________________
5) This is the most important of all! How long are you going to remain in that home? I know you can't predict the future but how old are your kids? If they are not yet school-age, do you like the public schools they will be attending? These kinds of questions may lead to the answer.
- I plan to stay in my home another ____________ years
So what you do is take the amount per year of doing nothing x the number of years you stay in the home to calculate the amount of doing nothing until I sell. Then subtract the amount you will spend to refinance and that gives you the amount you need to pay OR LESS to be better off refinancing instead of doing nothing. Divide this total amount by the number of months you would make a payment until you sold. (i.e. 2 years = 24 months). Go back to the amortization calculator link and put in the amount to borrow, the monthly payment which you just calulated and DELETE the interest rate so that box is empty. Hit Calculate and that is the interest rate you need to get when refinancing or Better.
Now you have all the information you need to make a mathematical and not an emotional decision. Here is an example:
- index = 6 month LIBOR = 5.349 November 2006
- margin = 2.25%
- periodic cap = 2.00%
- lifetime cap = 6.00%
- date of first adjustment = 2/1/2007
- current fixed rate of interest 5.75%
- current loan balance $135,000
- index + margin = 7.559% rounded up to the nearest .125% is 7.625%
- monthly payment is $955 x 12 months = $11,460
- By refinancing, I'll spend $4,050
- I plan on staying in my home another 2 years
- $11,460 x 2 years = $22,920
- $22,920 - cost to refinance $4,050 = $18,870
- $18,870 / 24 monthly payments = $786
By calculating using the amortization calculator, that means I need to refinance at 5.625% or less in order to make it worthwhile. If current rates are over 6% then sure, it seems like a great idea to refinance since your loan is about to adjust to 7.625% but by doing the steps above you learned that it would be more expensive to refinance then to do nothing at all.
©2006 Ken Stampe
Ken Stampe is a Mortgage Loan Originator, Mortgage Author and Mortgage Loan Officer Instructor living in Dallas, TX. Ken provided his first client a mortgage loan in 1996 and writes about home buying and mortgages to help clients make smart home mortgage loan decisions. Contact by email Ken@MortgageLoanDallas.com
What resource do SMART home buyers use?... Mortgage Calculator Bank.com
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