- The Washington Times - Wednesday, November 8, 2006

Q:I have a 7/1 ARM that I took out in 2002. The rate is 5.75 percent. All the recent talk of

skyrocketing payments for ARM holders is beginning to make me worry, even though I have almost three years left before my rate changes.

The loan started at $315,000 and now down to $297,000. My question is simple: Should I refinance now or wait?

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A: You’re right. The question is easy, but the answer isn’t. If I wanted to be flippant, I would tell you that if interest rates are higher in three years, you should refinance now. If interest rates are lower in three years, you should wait.

Of course, nobody knows for certain where interest rates will be in three years, which makes the answer more difficult. Before I give you any advice, I would like to give you my view of the upcoming wave of mortgages with rates that will be adjusting.

Some in the media have predicted severe economic fallout from the amount of ARMs scheduled to be recast higher in the coming years. While it’s true that both long- and short-term rates have risen, prompting higher mortgage rates for those ARM holders facing adjustment, the fact is that most folks need not worry about catastrophic consequences. Let’s illustrate:

Many ARMs are tied to the London Interbank Offering Rate, or LIBOR, a popular ARM index. The 12-month LIBOR is now hovering near 5.50 percent. Add a common margin of 2.25, and a “fully indexed” adjustable mortgage would hit 7.75 percent.

If your loan carries the same index and margin, your rate would jump from 5.75 percent to 7.75 percent if it were due to adjust today.

This is an increase of almost 35 percent. Using my calculator, I see that your payment would increase by more than $400 per month, from $1,838 to $2,256.

This is indeed a painful increase for most folks.

You may ask why I claim that ARM holders shouldn’t worry. The answer is simple. Short-term rates have risen at a far greater pace than long-term rates. This “flattening” of the yield curve has resulted in fully indexed adjustable rates to be significantly higher than fixed rates, allowing ARM holders to refinance to lower rates.

With zero-cost refinancing programs, ARM holders can refinance without losing equity in their homes. If your ARM rate were to adjust to 7.75 percent today, I would suggest that you refinance to a 30-year fixed-rate with zero points and zero closing costs.

I see that as of this writing, the rate for such a program is 6.25 percent for a $297,000 loan. The principal and interest payment becomes $1,829 — nine dollars less than your current payment.

Even though the rate jumps from 5.75 percent to 6.25 percent, the payment is lower because the balance begins at $297,000 rather than $315,000.

Also, you begin the 30-year cycle of a mortgage all over again.

Is this a good thing? Well, it sure beats staying in an ARM with a 7.75 percent rate. The bottom line is that thanks to the flat yield curve and zero- and low-cost refinancing options, most ARM holders can sidestep the payment shock of an adjusting ARM. Since I certainly cannot predict where interest rates will be in three years, I would advise that you seriously consider playing it safe and fixing your ARM under a scenario similar to the one described in this column.

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

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