December 2006:
Strengthen Your ARM Muscles:
Plan for 2007's Increases Today

If you are a homeowner with an adjustable-rate mortgage, you probably got in when interest rates were rock bottom. However, 2007 may be the year those rates rise – and your fixed (and low) payment period ends. While worrying about the hike is natural, you can reduce much of the stress with preparation and action.

Know the worst-case scenario
How much can your payment increase? Dig up your original loan documents and find out. Knowing what can happen under a variety of scenarios is crucial to planning. Mortgage contracts can be confusing, especially those for adjustable-rate mortgages (ARMs), so call your lender and ask questions if necessary.

Consider refinancing
Before (and even after) your payment adjusts, you may be able to refinance the loan. Options include taking out a new ARM, which can buy you time and keep the advantage of a low interest rate, or opting for a fixed-rate loan that offers the security of a steady rate and payment.

Before you borrow again, though, know that refinancing is not free! Closing costs are often three to five percent of the loan balance and you may also be charged a prepayment penalty – typically two percent of the remaining loan balance.

Make personal finance changes
Since you know your low payment won't last forever, set aside money now. Develop a budget to learn your current cash flow situation, and then make realistic changes based on your priorities. Try boosting your spending and saving power by selling assets, trimming unnecessary expenses, or increasing your income with a second or part-time job.

If you can't pay...
Attacking financial problems in the earliest possible stages is always best, so long before you miss a payment, contact your lender and explain your situation. Foreclosure prevention methods include:

  • A forbearance agreement – making lower or no payments for a set period of time.
  • A loan modification – changing the mortgage terms so you can make your payment easier.

If none of these solutions work, and your mortgage payment becomes too high to handle, consider selling the property and downsizing. While putting your home on the market may not be ideal, it's far better than being forced out.

You can greatly reduce ARM-related stress by planning for the inevitable. By doing so, you strengthen all your financial muscles for the coming year and beyond!