I know it sounds like the title of this Halloween's next horror movie, or maybe even a documentary about sports medicine, but the ARM's I'm referring to are obviously Adjustable Rate Mortgages. A big deal has been made over the past few months about how the next devastation to hit the real estate market will be the resetting of all of those nasty 5/1 ARM's that were done in 2004-2006, when nearly 50% of all loans were adjustable.
The furor has died down somewhat recently, perhaps because the growing "crisis" is possibly a blessing in disguise. I've had several clients, old and new, in the past few weeks call me in a panic because their rate was about to reset and they wanted to refinance into that "warm and fuzzy" 30-year fixed loan. Don't get me wrong, that isn't a bad phone call for me to get considering that is how I make a living; but many of these people have been shocked to hear my advice.
"Take a deep breath, relax, and don't do anything crazy."
I'm going to get a little elemenatary here so bear with me. Adjustable loans are based on two variables, the index and the margin. The index is the financial indicator that the loan is pegged to, such as the 1-year LIBOR, and the margin is the percentage added to the index by the lender as profit. There are some bad loans still out there, but the reality of the situation in many cases will probably be a rate reduction. Somewhere in all of this financial fear people have lost sight of the fact that adjustable rates don't always go up, they can adjust to a lower rate just as easily.
The majority of 5 and 7 year adjustable loans are tied to the 1-year LIBOR index, which today is 1.26, and have an average margin of 2.25%. Therefore, if your rate is adjusting today your new adjusted rate will be 3.51%, and in most cases will stay at that level for the next year. That is, of course, not taking into consideration the floor or the caps of any particular loan, but I believe it is safe to say that the majority of these big, scary ARM loans had initial interest rates above 3.5%. I know I don't remember writing many loans that started with a "3" five years ago.
So, as much as the refinance business adds to my bottom line, and as much as I love the additional income it provides; I must say I see absolutely no sense in refinancing purely out of fear right now. There are certainly sitations where it makes sense, but a purely knee-jerk reaction can be financially costly. I do strongly advocate putting any savings gained from a rate reduction into a safe side account. If you are in the position to save 2% over the next year on your mortgage, make sure you put that cash aside to offset any future costs if things ever do get ugly.
As a caveat, I'm sure there are those reading this and thinking it would be foolish not to lock in today's low rates on a 30-year fixed loan; and it's important to understand that there is no blanket, one-size-fits-all plan that is right for everyone. I have proven time and time again to Mortgage Management clients that we can be much more effective eliminating debt and increasing savings by refinancing every 5-7 years; but it is crucial to have someone experienced in your corner helping you manage the liability. Without that piece of the puzzle in place a 30-year fixed loan is probably a good way to go; even if it is considerably more expensive, and exactly what the bank wants you to do.
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