The benefit of ARMs is a period of lower payments before the rate starts to adjust. The risk is the adjustment and the payments associated with the adjusted rate if rates go up at the time of adjustment.
With interest-only ARMs, borrowers are obligated ob·li·gate
tr.v. ob·li·gat·ed, ob·li·gat·ing, ob·li·gates
1. To bind, compel, or constrain by a social, legal, or moral tie. See Synonyms at force.
2. To cause to be grateful or indebted; oblige. to pay only the interest and no principal during a predetermined interest-only period. The principal is then repaid over the remaining term of the mortgage and payments are recast re·cast
tr.v. re·cast, re·cast·ing, re·casts
1. To mold again: recast a bell.
2. to include principal and interest.
Here are some terms that will help you understand the current condition of your ARM.
Index and Margin
Interest rates on ARMs are tied to an index the lender assigns to your loan depending on which program best fits your needs. Lenders can use any of the fluctuating indexes that reflect the cost of borrowing. These indexes are published in any daily financial publication or report, such as The Wall Street Journal. The indexes that lenders use include the Monthly Treasury Average (MTA (1) (Message Transfer Agent or Mail Transfer Agent) The store and forward part of a messaging system. See messaging system.
(2) See M Technology Association.
1. (messaging) MTA - Message Transfer Agent. ), the London Interbank Offered Rate (LIBOR LIBOR
See: London Interbank Offered Rate
LIBOR
See London interbank offered rate (LIBOR). ), the Cost of Funds Index A Cost of Funds Index or COFI is a regional average of interest expenses incurred by financial institutions, which in turn is used as a base for calculating variable rate loans. (COFI COFI Cost of Funds Index
COFI Council Of Forest Industries (Canada)
COFI Community Organizing and Family Issues
COFI Checkout and Fault Isolation
COFI Coder/Decoder Filter (electrical engineering) ), and the Cost of Savings Income (COSI COSI Center Of Science and Industry (Columbus, OH, USA)
COSI Creative Outsourcing Solutions International (UK)
COSI Cost of Savings Index
COSI Closeout System Installation (NASA) ).
When the fixed period of your ARM has expired, the rate will adjust according to according to
prep.
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. the rise and fall of the assigned index. To make sure that the interest rate never hits a point where lenders are losing money, the lender will assign a margin to the ARM to work as the floor. The margin is set at closing and is fixed for the loan's term and can be anywhere from 2 percent to 5 percent. The adjusted rate is the set margin added to the fluctuating index.
Interest Rate Cap and Adjustment Period
Interest rates on ARMs are adjusted at intervals during the loan term. This interval is assigned according to the type of ARM you have. The rate could adjust every month, six months, or one year. Every ARM has a limit on how much your payment can go up. These interest rate caps determine the maximum number of percentage points your original interest rate can adjust over the life of the loan.
Should You Refinance Out of an Existing ARM?
Knowing whether or not to refinance out of an existing ARM can be as easy as knowing the market and calculating what your interest rate will be if the rate adjusts. You might think that if the current index plus margin will send your rate higher, you should refinance. But always take a look at the current market. If you refinance without doing some research, you could refinance into a rate that is higher than what it would be with the adjustment. If the fully indexed rate is still lower than what is currently available, this could buy you some time if the next adjustment will not be for another six to 12 months.
Some other strategies to consider:
- Fix your payments. If the fixed term on your ARM is about to expire, this may be a good time to refinance the ARM into a standard 15- or 30-year fixed loan. Then you'll know what your payments will be for the next 15 to 30 years. The ARM rate was good while it lasted, but now that rates are on the rise, you probably want to stop the rate from moving again at the next adjustment interval.
- Extend the fixed period on your existing ARM. If your ARM is expiring and you are keeping the mortgage, you could refinance into another ARM to extend the fixed period. You want to stop the rate and payments from adjusting to an uncomfortable level, but you won't be keeping this mortgage for more than, say, another five years. So look into another ARM to extend the fixed period. Again, check the market conditions. Rates on standard fixed-rate programs may be just as attractive as ARM rates at the time.
- Convert your interest-only payment to a principal and interest payment. If you have an interest-only loan Interest-only loan
A loan in which payment of principal is deferred and interest payments are the only current obligation. , it can be disheartening dis·heart·en
tr.v. dis·heart·ened, dis·heart·en·ing, dis·heart·ens
To shake or destroy the courage or resolution of; dispirit. See Synonyms at discourage. to look at your statement every month to see that no principal is being paid. If you like, you can always refinance that interest-only loan into a standard loan in which you pay principal and interest. Or maybe your existing loan's interest-only period is about to expire. If you let it, the payments will be refigured to include principal and interest and will be figured for the remaining term on the loan. This could make your payments go up if you haven't paid off any principal but now have only 20 or 25 years to pay it off. Consider refinancing and you could be doing yourself a big favor.
When Should You Refinance?
When deciding when to refinance out of an existing ARM or interest-only loan, think about the following:
- Break-even points and closing costs Closing Costs
The numerous expenses (over and above the price of the property) that buyers and sellers normally incur to complete a real estate transaction. Costs incurred include loan origination fee, discount points, appraisal fee, title search, title insurance, survey, taxes, . The cost of a refinance needs to be compared to the benefits received. Basically, you need to figure out your monthly savings from refinancing and divide the costs by that number to figure out your break-even point. Breaking even within three to four years would mean that every year after that point, you'll put money in your pocket from the savings you've established. If you won't be in the house that long, you probably won't break even, but other extenuating circumstances Facts surrounding the commission of a crime that work to mitigate or lessen it.
Extenuating circumstances render a crime less evil or reprehensible. They do not lower the degree of an offense, although they might reduce the punishment imposed. could propel you to go forward with a refinance. - Prepayment penalties. If your existing loan has a prepayment penalty, you may want to wait until the penalty period expires before refinancing your loan. This penalty could cost you at the table during refinancing. To find out if your loan has a penalty, you can check your payoff amount with your current lender. They'll also be able to tell you how much the penalty will be if you refinanced your loan. Additionally, you can also check the original closing papers to find out whether your loan has a penalty associated with it.
Now that you understand how your ARM is affected by indices, margins, rate caps, adjustment periods, and the current market, you can time your decision to refinance your ARM to get the best interest rate.
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