- The Washington Times - Thursday, September 15, 2005

Q:We purchased our house in January 2002 for $489,000. We put 20 percent down and

obtained a LIBOR ARM at 4 percent in the amount of $391,200.

We were delighted with our mortgage because it kept going down. It got as low

as 3 percent.

Now I’m afraid we have made a terrible mistake. About a year ago, we noticed that our rate was starting to climb. At first we didn’t worry about it because it was so low and a little spike didn’t matter.

We just received the latest notice from our lender, and it says our new rate is 5.75 percent. This is almost

double what we were paying

a year ago.

We originally took out an adjustable rate because we thought we would be in the house for five to seven years. I still don’t see us staying here for more than five years from now, so I think refinancing would be a waste of money. Do you have any suggestions?

A: I have a great suggestion, but first, let’s first reverse your train of thought.

Considering the objectives you have laid out, you did not make a “terrible mistake.” In fact, you made an excellent decision to take out a LIBOR ARM in 2002.

For readers who are unfamiliar with it, LIBOR stands for London Interbank Offering Rate, which is the rate European banks charge each other for overnight funds.

This rate is an index used for some adjustable-rate mortgages, and it doesn’t surprise me that back in 2002 you found a LIBOR ARM to be appealing. Let’s take a look

Indeed, LIBOR-based adjustable mortgages were hovering around 4 percent in early 2002. At the same time, 30-year fixed-rate mortgages were floating at what is now considered a lofty 7 percent to 7.25 percent.

Clearly, the big spread between long-term and short-term interest rates warranted some attention.

I’m not one to predict interest rates, but back in 2002, it was a pretty safe bet that short-term rates, including the LIBOR, were going to continue to fall. The Federal Reserve Board did not make a secret of its policy to ease credit, or lower short-term rates, in the aftermath of the September 11 terrorist attacks. The LIBOR index has a history of following the movements of U.S. short-term interest rates, which are controlled by the Federal Reserve Board.

So what happened? The rates on LIBOR-based mortgages sank. By the end of 2002, the folks who had taken out a LIBOR mortgage at 4 percent were paying 3.50 percent. By mid-2003, they were paying 3.25 percent.

By January 2004, they were paying a rock-bottom 3 percent for their mortgage money.

Eventually, though, things reverse course, and the LIBOR is no exception. Halfway through 2004, LIBOR-based loans started to creep up. Long-term rates, which also had fallen considerably in 2003, shot up much faster. While the LIBOR had risen by only 0.25 percent or so, long-term rates rose by almost 1 percent.

By the end of 2004, LIBOR folks were paying somewhere between 4.25 percent and 4.50 percent — certainly a big spike upward but still not a bad rate considering the big picture.

Then something funny happened. Long-term rates peaked in 2004 but have declined considerably since then, defying most analysts’ predictions. Meanwhile, as the economy has picked up steam, Fed Chairman Alan Greenspan has continued his credit-tightening campaign by raising short-term rates, resulting in a higher LIBOR.

Let’s fast forward to the present day. Most LIBOR-based mortgage holders are facing fully indexed rates in the 5.75 percent to 6.25 percent range. What we have is a “flattening” of the yield curve. This means that the spread between long-term rates and short-term rates is very thin.

This is the opposite scenario from 2002, when a monthly LIBOR carried a rate of 4 percent and a fixed-rate loan hovered at more than 7 percent.

I did a little number-crunching and came up with some interesting information. The average rate on a LIBOR-based monthly ARM between 2002 and August 2005 was just 3.83 percent.

So, despite your current 5.75 percent rate, you should be happy to know that your average rate has been at rock bottom for almost four years.

Also, thanks to the flat yield curve and the availability of zero-cost and low-cost refinance programs, you can refinance your house at a great rate.

Because you plan on holding the property for just five more years, I would suggest refinancing to a 5/1 ARM, which carries a fixed rate for five years.

I see that as of as of this writing, you should be able to refinance your loan to a 5/1 ARM with few or no closing costs to a rate of about 5.625 percent, a rate less than your current monthly ARM.

If we take the average LIBOR rate of 3.83 percent that you have paid for the past four years and blend it with a 5.625 percent rate for the next five years, we come up with an average mortgage rate of less than 5 percent over a nine-year period. That’s fantastic.

Yes, indeed, you made a great decision in 2002 — but it’s time to abandon the monthly adjustable and take out a loan that carries a fixed rate for a while.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]).

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