Saturday, August 18, 2007

For ARM Loans Set to Go Up, Preparation is Your Best Defense

by Nancy Osborne, COO of ERATE

If you have taken out an adjustable rate mortgage in the past several years, the news looming on the horizon about forthcoming rate increases could not have escaped your attention. It is predicted that some $1.5 trillion in adjustable rate loans are due to reset in the very near future. The current rate of mortgage defaults is hovering around 4%-5% and is expected to double by mid 2008. We are all aware that the Fed had been moving short term rates in only one direction, higher and while long term rates are not controlled directly by the Fed, they certainly have a strong influence on their direction. Given the current liquidity crisis rippling through Wall Street, as well as the global markets, it is assumed that the Feds next move may be to take a neutral or a declining position on rates to stave off any further economic impact of these market gyrations. However based on current market conditions, one may reasonably presume their adjustable rate loan will increase in the neighborhood of 1.5% at the first adjustment. On a $300,000 mortgage this will result in an increase in payment of approximately $279 per month, this is what is referred to in the mortgage industry as payment shock. It may seem like a relatively small amount, yet it is significant enough that you need to plan and prepare for it. So exactly what should you do?

The first thought you have may be to refinance, but how long you anticipate remaining in your home will determine whether or not it is worth while option to consider. If you anticipate wanting or needing to move within a period of 5 years or less then refinancing may only make sense if you could obtain a "no closing cost mortgage" at a rate close to or lower than the rate at your ARMs scheduled adjustment. While it is likely at the first adjustment on your ARM, your rate will go up, it is not clear that it will continue to go up after that. Therefore you may be better off, if you have a short term expectation of ownership, to simply absorb the rate increase until the next sequence of rate decreases by the Fed, at which time you could logically refinance into more attractive fixed rate terms. The costs of refinancing are significant and typically in the range of 2-3% of the loan amount, so until fixed rates are at a level where they are low enough for these expenses to be a reasonable trade off, you'll want to consider only a "no point no fee refinance" option and then only if the rate is close to or less than the rate of your ARM after the scheduled adjustment.

If you are not in a position to refinance, then how should you manage the burden of payment shock? First, simply knowing that it is coming is a big step in preparing for it. One option would be to scale back on your expenses in an amount equivalent to the payment increase. Good places to start looking for expenses to shave would be entertainment (including eliminating cable or satellite services), eating out, vacations, club memberships. Next examine utilities, such as converting to more conservation in your energy usage, checking your phone bill for both long distance and local coverage savings you may not be taking advantage of, eliminating any land line expenses which you may not truly need. Also you may want to examine any insurance premiums which could be reduced by increasing your deductibles. This could pertain to your homeowners, auto as well as your medical coverage (assuming you are not covered by your employer).

Other more drastic efforts could be taken such as having a non-working spouse or family member could get a part-time job or the primary wage earner could get a second job if possible. Lastly if you feel that the rate and payment increase is simply more than you will be able to handle, you want to contact your mortgage lender right away and let them know you are in trouble. Start the lines of communication early because the sooner you get your lender involved, the more options they will be able to offer to help you prepare. Whatever you do, do not wait until the 11th hour when you are already delinquent and have damaged your credit. Believe it or not your lender may well be your best ally in this situation because the last thing they want is to have to take your home, have it on their books and to have to sell it off themselves. Lastly you could consider contacting a successful real estate agent with a proven track record in your neighborhood and have them sell your home for you. Hopefully you will not sell at a loss as this could produce a problem for you and your lender if you put little or nothing down and have no equity in the home. If you are upside down on the loan (that is you have negative equity) you should plan on receiving a 1099 from your lender for this difference and it will likely be treated as income to you for tax purposes. So the objective is to start planning now so you can carefully consider all of your options and not have to make a rushed, hurried decision when that fateful adjustment date actually arrives.

The information contained on this website is provided as a supplemental educational resource. Readers having legal or tax questions are urged to obtain advice from their professional legal or tax advisors. While the aforementioned information has been collected from a variety of sources deemed reliable, it is not guaranteed and should be independently verified.

Nancy Osborne,   Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.

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