Do you have an adjustable rate mortgage that is due to adjust this year? If so, you’ve got plenty of company. There are a lot of Adjustable Rate Mortgages (ARMs) resetting this year. I’ve seen estimates as high as one trillion dollars worth – that’s one with twelve zeros behind it! That is serious money, and I’ve read a lot of commentary about how damaging this could be to our economy this year. But if you have an ARM, should you be worried that your interest rates are going to go pop up and make your payment unaffordable? Probably not. Rush out to illinois mortgage refinancing ? Not necessarily. In a lot of ways ARMs have gotten a bad rap. To see how an ARM reset would affect you, you need to understand how an ARM works.

The most popular versions are what is called hybrid ARMs, these are a combination of a fixed rate and an adjustable. That means they are fixed for a certain time span, 3, 5 or 7 years are the most popular, and converted into a one year ARM after the fixed period ends. So how does your ARM reset? Your ARM changes are based on two things that are set up at the beginning: the index, and the margin. The first part, the index, refers to the financial indicator the rate is based on. Different indexes are used, but they all move up and down based on the strength of the economy. The second part of an ARM loan is the margin. This is set at the closing, and it always stays the same.

So the first step to see what your new rate will be is to add the margin to the index. With the recent Fed rate cuts, all the short term indexes are down sharply. The current 1 year treasury index, a common index in ARM loans, is now around 2.11%. Adding in the margin, typically 2.75%, you get a fully indexed rate of 4.86%. Not a bad rate at all – quite a bit lower than what you could get by refinancing.

But this doesn’t necessarily give you your final rate. There’s one more step. Most ARMS have caps built in to them. Your rate typically can’t increase more than 2% per year, and no more than 6% over the lifetime of the loan. (That’s not the case with all ARMs, so take a look at your mortgage note to make sure.) So if you bought your home back in 2003 with a 5 year ARM, and maybe you bought when rates were near the bottom with the starting rate at 3.75%, if your cap is 2% at the first adjustment, your new rate can’t be higher than 5.75%, even if the fully adjusted rate is higher.

The other thing to keep in mind is how long you plan on staying in your home. If this is your forever home and you want to stay there for the long term, it might make sense to refinance and lock in to the current low rates, even if they are higher than what your adjusted rate would be. If you are going to be there for at least a few more years, refinancing might still make sense, especially if you refinance with low or no closing costs. But if you don’t plan on staying in your home for more than a year or two, you’re better off doing nothing. The current rates are better than your other options, and the worst case scenario isn’t all that bad.

If you have an ARM with a sub prime mortgage your situation will be worse. The margin on Sub Prime loans can be 6%, which means your payment could shoot higher causing real problems. If you have an Option ARM and you’ve been paying just the minimum payment, you owe more now than when you started, and you are on track for some real trouble. In these cases refinancing makes a lot of sense, but with the changes in mortgage guidelines you may find it hard to qualify. But we will talk about that in another post.

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