This year, nearly $1.5 trillion worth of adjustable rate mortgages (ARMs) are due to reset. That’s up from the already considerable $300 billion worth that reset in 2006. Why the sudden increase in mortgages up for adjustment? It’s the result of several factors coming together.
In recent years, interest rates have been at historic lows. It’s also been a period of falling interest rates. To get the lowest rate possible, and leave the door open to potentially get an even lower rate in the future, many home buyers chose an adjustable rate mortgage, as opposed to a fixed-term loan. Many existing mortgage holders also took advantage of low ARM rates to refinance in order to obtain a lower payment or to draw funds from their home equity. Soaring home prices and low interest rates combined to make these options extremely attractive to homeowners.
As a result, the Mortgage Bankers Association reports that today nearly 25 percent of mortgages carry adjustable interest rates. That’s not surprising considering the savings they’ve provided over the past few years. In 2003, for example, the interest rate on a 30-year fixed-rate loan was around 6.5 percent, whereas ARM rates were under 4 percent.
Many of today’s ARMs are also hybrid products. They combine the features of both fixed rate and adjustable rate mortgages, typically starting off with several years of fixed payments before converting to an annually adjusted ARM. Someone who took a 4/1 hybrid ARM in 2003 would have had a fixed interest rate for the first four years and would only now be facing an adjustment.
The problem is that many ARMs due to reset this year will be doing so at a considerably higher interest rate. Not only have interest rates increased but the gap between fixed and adjustable rate mortgages has narrowed. Those who took out an ARM for less than 4 percent back in 2003 could see their mortgage rate jump to 7.5 percent after the adjustment.
But even if your mortgage is resetting at a higher rate, the news isn’t all bad. Before you panic, consider the following:
• You’ve benefited from a low initial rate. Remember, the fact that you chose a low-interest ARM means you’ve most likely already reaped the benefit of saving several thousand dollars a year during the first few years of your mortgage.
• Mortgage interest is usually tax deductible. Even though your payments may be increasing when your ARM resets, the fact that mortgage interest is usually tax deductible means there may be less net impact than you may expect on your overall finances.
• You can refinance to a fixed-rate mortgage. If you’re concerned interest rates may continue to rise and want the security of knowing your monthly payment won’t rise to an unaffordable level, you have the option of refinancing to a fixed-rate loan.
• Historically today’s interest rates are still low. Twenty years ago any mortgage under 10 percent was a great deal. Today’s rates are still historically low.
• You chose the right mortgage if you plan to move soon. Choosing an ARM was the right decision if it enabled you to save money during most of the years you lived in your home. Those savings should more than offset a short period of higher interest payments just before you sell your home.
• You have options. If you’re worried about your adjustable rate mortgage resetting, you can calculate how much you will pay after your ARM adjusts
By knowing what to expect and by planning ahead, you can stop worrying about what the future may hold and start coming up with a solution that can meet your budget and financial needs.