Ethical Homes

Following up on our last article on how homeowners may want to refinance their ARMs to lock in a fixed rate, Money/CNN has an interesting article giving some specific numbers as examples of how looming rate adjustments might affect a homeowner’s bottom line.

It’s worth noting, however, that while their numbers are fairly accurate, they make two assumptions that don’t necessarily hold true in this market:

• They use the national average ARM amount of $300,000; in my experience, borrowers in this market have been getting ARMs in closer to the $450k-$600k range. That means that the increase for the “typical” ARM that they calculate would be closer to $500-$750 more per month, rather than the $385 that they calculate.
• They note that most 3/1 ARMs have caps that limit rate increases to 2 percentage points per year. In this area, at least, most lenders actually have three different caps that apply to their ARMs—a lifetime cap that limits how high the rate can ever go (usually around 5-8 percentage points higher than the initial rate), a per-year or annual cap (often the 2 percent cap that the article describes), and most importantly, a “first-adjustment” cap that supersedes the normal annual cap, and which is often the same as the lifetime cap. For an ARM with 8/2/8 lifetime/annual/first-adjustment caps, then, the initial sticker shock could be much worse—and unfortunately, much harder to predict, since the exact amount of the initial adjustment will depend on the specific value of the index that the ARM is tied to.

Especially for homeowners whose ARMs have large first-adjustment caps, it’s extremely important that they not base their final decision on just one possible outcome (such as the best-case or worst-case scenario, or even a middle-of-the-road outcome). Instead, they should look at all of the possible outcomes for both refinancing and staying with the current ARM, and do a thorough risk analysis: outcomes should be sorted into categories like “unacceptable and need to be avoided”, “painful but tolerable”, and “desirable”, and then the options that lead to unacceptable outcomes should be eliminated, and contingencies and hedges should be considered to see which “painful but tolerable” outcomes might be worth the risk.

Interested in figuring out if you should refinance or not, but not sure where to start? Let us know and we’ll gladly help you analyze your options, and put you in touch with a good lender if you do decide to refinance.