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Rate Update & ARMs

Mortgage rates moved higher last week as continued economic improvement is leading investors out of bonds and into the stock market. Currently, the 30 Year Fixed is 4.750% (4.880% APR) and the 15 Year Fixed is 4.000% (4.226% APR). This week we will see Retail Sales, Housing Starts & Building Permits, the monthly inflation reports and Jobless Claims.

In light of the recent moves higher in mortgage interest rates, we thought this would be a great opportunity to give the readers a refresher course on the Adjustable Rate Mortgage (ARM). An ARM loan may be the right option if you want to:

  • Lower your initial monthly payments
  • Qualify for a larger loan amount
  • Increase your purchase power
  • Stay in your home for a short time period
  • Maximize your investment options

By choosing a LIBOR ARM, your payments gradually reduce the principal loan balance during the initial fixed period, at the same rate as a FIXED rate mortgage.

None of the ARM loans have a prepayment penalty, so you can refinance at anytime. 

Common misconceptions make people judge the ARM as too risky. Simply, some people pay the extra interest for security and others choose the ARM to save cash every month. If the economy experiences inflation that adjusts your rate to the lifetime cap at the initial adjustment, then the savings rates will be much higher and typically real estate values have also increased substantially. There is a lot of analysis that can and should be done to see if the ARM is the right loan for you. You can see a historical average of the 1-Year LIBOR rate here

The interest rate on a 5/1 LIBOR ARM is fixed for the first five years and then adjusts every year for the remainder of the loan term. Today the rate is 2.500% (2.630% APR). After five years, the rate will adjust to the market rate of the LIBOR index plus the margin.  LIBOR stands for London Inter Bank Offer Rate. It is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London. It is a standard financial index used in US capital markets and can be found in the Wall Street Journal. The last reported monthly rate was 0.78125%.  So, if you had a 5/1 LIBOR ARM and the interest rate was adjusting today, the new rate would be 0.78125% plus 2.250% which equals 3.03125%.

The interest rate cap structure of a mortgage gives the consumer protection from large interest rate increases and also helps the lender to understand the worst case scenario for the payment. For example, 5/1 ARMs offer a 5/2/5 interest rate cap structure. In the initial or first adjustment period after the five-year initial fixed period, the rate could adjust a maximum of either 5% up or down. At all subsequent annual adjustments, the rate can only adjust 2% up or down. The lifetime cap limits the ARM rate increase to 5% over the initial rate during the loan term. 

Written by Central Coast Lending - Go to Central Coast Lending's Website/Profile