ARM Borrowers: Is It Time To Refinance?by Tim Manni
Everybody knows interest rates are low and that there’s a lot of refi activity going on. So instead of focusing this week’s Market Trends recap on last week’s movement of mortgage rates, we decided to examine the question “if I’m an ARM borrower, should I refi?”
In today’s market at least, fixed-rate to fixed-rate refinancing is arguably the most common occurrence. However, given the fact that short-term interest rates are so low, especially the short-term rates which govern ARMs, we wondered how many ARM borrowers would be interested in switching products?
We took a stab at providing some context that takes a brief look at the issue facing some borrowers (emphasis added):
With many common ARMs, and especially jumbo and “alt-A” product, it’s worth noting that there can be two issues an ARM borrower might face.
There are ARM interest rate reSETS (where any fixed-rate period comes to an end, and the loan’s interest rate is changed using the “Index plus Margin, subject to Caps” rule) and ARM payment reCASTS, where the loan switches from non- or negatively-amortizing payments to fully-amortizing ones. These can and do occur at the same time.
A borrower who has been paying an interest-only (I/O) payment for a 5/1 ARM who is coming to a reset AND recast point will of course see their original loan balance subject to a shorter remaining payoff period.
This week in July 2005, a borrower with a $100,000 5/1 ARM with I/O payments for the first five years would have an interest rate of about 5.25%, and a monthly I/O payment of $437.
Fast forward five years. The loan balance is the same, but the loan term is five years shorter and the payment must now include principal. Providing an offset to the compressed term and requirement of principal repayment, the loan’s new interest rate would fall to about 3.4%, so the monthly payment “shock” of this change would consist of an increase of $62 per month, hardly catastrophic.
If this borrower can meet today’s stricter criteria and successfully refinance, a likely interest rate would be perhaps 4.75% for a new 30-year FRM. The corresponding monthly payment would rise to $525, an increase of $88 per month, but of course provide a more permanent solution to interest rate concerns.
Borrowers who have made fully amortizing payments throughout their ARM’s first five years can refinance as above to a new 30-year FRM carrying a payment of $481… or can hold onto their ARM and see their fully-amortizing payment slip by about $96 per month. It is worth mentioning that taking a new loan with a new 30-year term will of course see the borrower pay somewhat more in interest over the combined (35-year) term of the two loans.
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For more on this subject, be sure to read our guest post from the personal finance blog Get Rich Slowly: “Ask the Readers: Should I Stick With My Adjustable-Rate Mortgage?”
HSH.com’s free Market Trends Newsletter, an in-depth analysis of various financial markets from the week prior, is published every Monday. Email subscribers receive it in their inbox Friday night, so sign up today! Also, be sure to check in with our Market Trends blog for all news relating to any weekly shift in mortgage rates.