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Personal Finance

Sell Home or Refi ARM: A Matter of Timing


Dear Dr. Don,
I currently have a 6%, interest-only, five-year ARM, which is scheduled to readjust next April. I would like to sell this property, but I would sustain a substantial loss in today's market. I could refinance, but the closing costs are considerable.

My current lender has told me that the first rate adjustment would be 2.25% plus the Libor index published Feb. 16, 2012, and could conceivably be lower than my existing rate. Would it be a mistake to wait until next February before deciding on what action to take?
-- Frank Forecast

Dear Frank,
Interest-only mortgages typically aren't interest-only forever -- usually just the first five to 10 years of the loan. You need to know when your interest-only loan converts to an amortized mortgage. With an amortized mortgage, the loan payment is sized to cover the month's interest expense plus pay off the loan over the remaining loan term. You can calculate an amortized payment using Bankrate's mortgage calculator.

Libor is the London Interbank Offered Rate. It's the interest rate banks charge other banks to borrow reserves in the London market. There are a lot of different Libor indexes, so you need to know which one your mortgage uses when setting its interest rate. Bankrate reports four different Libor indexes. If your mortgage were to reset based on Libor indexes posted May 11, 2011, by adding 2.25% to any one of these Libor rates, you'd end up with a mortgage rate of 3% or less.

You'll also want to know if the interest rate on your mortgage is subject to limitations on how much the interest rate can move on a reset date and over the life of the loan. These are known as loan caps. The loan also may have a floor rate that establishes the minimum interest rate on the loan. If so, you wouldn't be able to capture a low rate on the reset date.

Closing costs shouldn't be excessive. In Bankrate's 2010 Closing Costs Study, the national average for closing costs on a $200,000 purchase mortgage was $3,741.

If you want to wait for your home's value to appreciate, you have a longer planning horizon than the next reset date on your mortgage. With a longer horizon, refinancing at today's low rates can buy you time without taking on the interest rate risk of an annual reset on an adjustable-rate mortgage.

As I write this column, the Bankrate national average for a 30-year, fixed-rate mortgage is 4.82% and a new 5/1 ARM (not interest-only) is 3.52%.

Once you know the particulars of your interest-only mortgage, you can make a better decision as to whether you want to wait and see what's going on with interest rates or commit to refinancing your home. Bankrate's weekly "Mortgage Rate Trend Index" and "Mortgage Analysis" will help you keep your finger on the pulse of the mortgage market.

Bank Rates

Loan Type Graph Rate +/- Last Week
30 Y Fixed Graph 4.22% dw 4.27%  
15 Y Fixed Graph 3.19% dw 3.24%  
30 Y Fixed Jumbo Graph 4.37% dw 4.42%  
5/1 ARM Graph 3.30% dw 3.33%  
5/1 Jumbo ARM Graph 3.35% dw 3.38%  
Loan Type Graph Rate +/- Last Week
$30K HELOC Graph 4.38% dw 4.54%  
$50K HELOC Graph 4.06% dw 4.09%  
$30K Loan Graph 5.07% dw 5.08%  
$50K Loan Graph 4.55% dw 4.56%  
$75K Loan Graph 4.55% dw 4.56%  
Loan Type Graph Rate +/- Last Week
36 M New Graph 3.06% -- 3.06%  
36 M Used Graph 3.28% dw 3.29%  
48 M New Graph 3.05% up 2.96%  
48 M Used Graph 2.88% dw 2.96%  
60 M New Graph 3.08% dw 3.21%  
Loan Type Graph Yield +/- Last Week
6 month Graph 0.36% -- 0.36%  
1 yr Graph 0.60% -- 0.60%  
5 yr Graph 1.45% up 1.44%