Strong-arm Your ARM:
If you are a homeowner with an adjustable-rate mortgage, you may be worried about your finances every time interest rates rise. To prepare for the hike, know how ARMs work (many people aren’t completely aware of the details) and what you can do to plan for future payment increases.
In essence, an index is a statistical measure of the changes in a group of stocks – it represents a portion of an overall market. All ARMs are tied to indexes that are based on short-term interest rates, such as the 12-Month Treasury Average and the London Inter Bank Offering Rates, and change constantly with the market. When interest rates are low, the lending rate is also low – meaning great deals for homebuyers. When they are high, loans are more expensive.
An ARM may have a period of fixed interest that is three, five, or seven years. For example, if you have a 5/1 ARM (the first number stands for the number of years in the initial fixed period, and the second indicates how often the new rate will adjust), the initial interest rate will be the same for the first five years, and then will adjust annually for the remaining term.
There are several types of caps that may apply to your ARM, and the amount the interest rate – and therefore your payment – can go up depends on them:
For example, that 5/1 ARM may have a two percent cap on interest rate increases for each adjustment period, and a six percent cap on interest rate increases over the life of the loan. If interest rates go up, the interest on your loan can only increase by two percent per adjustment period. However, if interest rates continue to rise, your rate can’t increase further, because it reached the six percent overall cap in the first three periods.
Planning for the Increase
If the interest rate rises to the point where your payment is not going to work with your current financial situation, it is time to take action. Doing nothing and hoping for the best is never a good strategy.
Whichever loan you choose though, be aware that refinancing is not free. In fact, closing costs can be very expensive – often three to five percent of the loan balance. You may also be charged a prepayment penalty, which is typically two percent of the remaining loan balance.
The longer you remain in the home after refinancing, the more economic sense it makes, since you can recoup the costs over time.
Personal Finance Changes
Just knowing that your low payment will not last forever may be incentive enough to aggressively set aside money for the increase. To save effectively, develop a comprehensive budget to understand your current cash flow situation, and then make sensible, realistic changes based on your priorities. You may be able to boost your spending and saving power by liquidating assets, reducing or eliminating unnecessary expenses, or increasing your income with a second or part-time job.
Change is rarely easy, particularly when it means tightening your belt. On the other hand, if your goal is to be able meet your upcoming monthly mortgage payments without stress, the effort will be worthwhile.
Early Delinquency Intervention
Early Delinquency Intervention (EDI) involves addressing the financial problem in the earliest possible stages. Lenders do not want to take your home through foreclosure – the vast majority are only interested in seeing that payments are made each month as agreed in the mortgage terms.
Long before you miss a payment, contact your lender and explain your situation. Methods to keep your home from foreclosure include:
Remember, too, that if the monthly payments are just too high for comfort you can sell the property and downsize, either by buying a less expensive home or choosing to rent instead. How you deal with an ARM’s rate and payment increase is up to you – just be sure you understand the terms of your loan and how it works, you’ve carefully considered each of your options, and you actively prepare for your final choice.