Adjustable Rate Mortgages

Adjustable Rate Mortgages are Skyrocketing

Are you stuck in an Adjustable Rate Mortgage? It is not too late to refinance and get a fixed rate mortgage now. Adjustable rates are skyrocketing and getting out of control. The recent implosion of the sub prime market is having negative effects on interest rates. If you have an adjustable rate and it is going up you could save thousands by refinancing. Even if you have to use some equity it is better than paying high interest over 15 or more years.

When Should You Refinance?

The answer is simple... When you can save more than the costs of refinancing. If you are considering a refinance just use this simple formula.

Total Remaining Cost of Current Mortgage (Multiply Your Current Payment x Remaining Months)
-
Total Cost of New Mortgage (New Payment x Mortgage Term... Normally 360)
+
Total Closing Costs (All Costs Incurred During the Mortgage Process = New Loan Amount - Mortgage Payoff)
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= Net Savings or Losses from New Loan

Example.
Original Purchase Price of $100,000
Current Mortgage Payoff = $97,952 after 36 payments
Current Monthly Payment = $804 x 324 remaining payments at 9% interest rate which can adjust up or down but never go below 7%.
= $260,496 is the Total Remaining Cost of Current Mortgage
-
New Mortgage Amount of $101,000
New Monthly Payment = $671 x 360 payments at 7% interest rate fixed for 30 years.
= $241,560 is the Total Cost of New Mortgage
+
Total Closing Costs = $3,048
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$260,496
-
$241,560
+
$3,048
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= $21,984 in real savings over the life of the loan

In this example after making 3 full years of payments and increasing the term and paying closing costs you would still net a savings of over $20,000 dollars.

Additional Factors to Consider

There are more factors that are important to consider when talking about adjustable rates. Most adjustable rate mortgages have what is called a "floor rate". This means that no matter how low the rates which the loan is figured from go your actual rate can only go to a certain point. Normally the rate you started with. This means if your initial rate was 8%, even if rates went down to 7% you would still have to pay 8% as this is your "floor rate". The alternative is if rates go up you have a "cap rate". So if you start at 8% and rates go up and your cap rate is 16% then that is what you may end up paying one day. Lets look at an example of a worst case scenario. And this really does happen.

Example.
Mr. Thompson has an adjustable rate mortgage. He currently has a rate of 8% and has been paying his payments on time for the last 24 months since he bought his home. He got a great deal and paid $80,000 for a home that was worth $100,000. His monthly payment is $587 which he can easily afford on the $3000 per month salary he receives. It is now his 25 month and his rate is ready to start adjusting. His "floor rate" is 8% and his "cap rate" is 14%. In the last 6 months sub prime mortgage rate factors have skyrocketed and rates are going up. Current rates are at around 12%. He does have a clause in his mortgage which limits the adjustments to 2% every 6 months. Here is what happens over the next 18 months.

First 6 months - Payment adjusts to $702 per month at 10% interest.
Next 6 months - Payment adjusts to $822 per month at 12% interest and Mr. Thompson is feeling the crunch.
Next 6 months - Payment adjusts again to $947 per month at the "cap" of 14% interest. Mr. Thompson's payment has almost doubled and it is beginning to be difficult to keep up with the payment.

As long as Mr. Thompson refinances before he gets behind in payments he should be able to get a fixed rate at or below his current rates. He has made every payment so far on time and many lenders will now consider him for a loan. If he waits until it is too late after the payment gets too high and he misses payments (which is exactly what the sub prime lender wants) he won't be able to refinance and will either have to make the higher payments, sell his home or be foreclosed on. Which for the latter the lender will be happy to do so as they are getting a home worth $100,000 and they only have a loan for $80,000.

Do Not Wait Until It Is Too Late

In Mr.Thompson's example he is a prime candidate to refinance to a fixed rate. Lets look at how much he could save at the worst case scenario if he waits the 18 months.

$947 / month x 318 remaining payments = $301,146
-
New Loan for $80,000 for 30 years at 8%
$587 / month x 360 months = $211,320
+
Closing Costs = $3,000
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Savings of $92,826

That is a real savings of almost $3,100 per year.

Now really what could you do with that extra money every month?

Banks would love you to think that your homes equity is the only thing that matters. And that if you save a little equity it is like money in the bank. Just think about it if you pay all that extra interest just to save a little equity thats like money that will never even see your bank let alone be a nest egg for later on. Equity is important but the total cost of any loan is the most important mortgage item.