Remember way back in 2006, when everyone was in a frenzy to buy a house, any house, with whatever mortgage they could grab? In many cases, it meant signing up for adjustable-rate mortgages that would reset in half a decade.
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Move forward those five years and here we are. For the next 13 months, some $20 billion in adjustable-rate loans are scheduled to reset every month, according to figures from Credit Suisse.
That means the interest rates and monthly payments will adjust -- in most cases, downward, because of interest rate declines. Homeowners will have to decide whether to keep their loans or replace them with a refinance.
In a few cases, the adjustment of interest-only loans will make the monthly payments go up, even if their interest rates go down. And some homeowners may not be able to refinance, because their homes have dropped in value and they don't have enough equity to qualify for a new loan.
Anyone sitting on one of these loans now must weigh the options with the idea that today's low rates are unlikely to last for the life of the loans, which will now begin to reset annually. Here are some considerations.
-- Thank Ben Bernanke. The Federal Reserve chairman's accommodative monetary policy has held the short-term rates upon which adjustable loans are based very, very low. That means that someone who originally took out an average 6.35% mortgage five years ago will see their rate adjust to the neighborhood of 3%, reports Keith Gumbinger of HSH Associates (www.hsh.com), a research firm.
On a $300,000 loan, their principal and interest payment would drop from the $1,867 they had been paying to $1,329, says Gumbinger. And who couldn't use an extra $500 or so a month?
-- That doesn't mean you should sit on it. Having that lower payment for a year is dandy, but 25 years (the time remaining on these loans) is a very long time, and rates are likely to rise from their current low levels. Should they blow through the roof, you could end up paying 5% next year, 7% the year after that, and so on. The maximum level for most variable rate loans made at 6.35% is 11.35%. Think that can't happen? They were there in 1985, on the way down from 12.2%.
-- You have choices. If you think you're going to be in your home for five years or less, keeping your loan might be the best bet. If you want to stay there a long time, this might be the time to lock in a 30-year rate. At around 4.6%, "rates are about the best they've been all year," says mortgage industry consultant Rob Chrisman. Furthermore, this might be your last chance to grab a 30-year, fixed-rate loan, suggests Gumbinger. He's speculating that they could go away altogether or become much more expensive once Washington reforms mortgage-buying giants Fannie Mae and Freddie Mac.
One other option is to refinance your current variable rate loan with a new variable rate loan. That may seem strange, but if you could lock in five years at 3.44% (the current going rate on 5/1 ARMs, according to HSH), that might be worth the refi costs. Finally, note that 15-year loans are now running 3.8%, says Bankrate. You could take those monthly savings and put them toward the bigger payments that would come with a shorter maturity loan.
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-- You'll have to do the math. Compare your options with an online calculator, like the one on Bankrate.com (here).
-- Call your bank, if you don't qualify for any of those new deals. You may not be able to refinance because you're underwater on the loan, meaning you owe more on the home than it is worth. Or you may have suffered a financial setback and stopped making mortgage payments. Roughly one-third of the resetting mortgages are delinquent, says Credit Suisse. It's possible the downward reset could make your payment more affordable, and you could catch up. Or that the new low rates will make your lender a little more willing to modify your loan. At the new 3% rate, they'll be giving up a lot less interest than they would have if your rate was still 6%.