Friday, June 04, 2010
When I bought my home in May of 2006, I thought I was doing all the right things, I put 5% down (which was 5% more than most people put down) and financed 80% on my first mortgage and 15% on my second mortgage. I did a full documentation loan (I had the option of doing a "Stated Income" loan but because I made enough to qualify for the loan, there was no reason to do that) providing tax returns, pay stubs, a vial of my blood, the whole 9 yards. BUT my 1st mortgage is an Interest Only Adjustable Rate Mortgage. Meaning that the payment I make each month only pays the interest, and never pays down the principle. Hindsight is always 20/20 and if I had it all to do over again, I would have just bitten the bullet and done a 30 year fixed rate loan. But I was counting on home prices continuing to rise and in 2011 when my mortgage reset, I would either just sell my home, or refinance it into a 30 year fixed rate loan. We all drank the Kool-Aid in 2003 - 2007. In fact, 4 months after I closed on my home, another just like it sold in my neighborhood for $65,000 more than what I paid! I felt like a genius! But it turns out that was the ABSOLUTE peak of the market and home prices started to fall at that point. Soon that $65,000 was gone, as was the 5% I put down on the house. And they continued to fall. At this point I probably owe about $25,000 more than my home is worth. So now what?
Well thanks to the Obama administration's housing policy changes, I can now do a HARP (Home Affordable Refinance Program) refinance on my current home that will allow me to refinance my first mortgage into a 30 year fixed rate even though I have a negative equity position. With my current loan balance and current interest rates that locks me into a $400.00 per month increase in my payment. Right now. But what would happen if I rode it out and let my interest rate reset in June of 2011? What would that REALLY mean to me? To find out, I had to dig out my Deed of Trust. What I learned actually gave me peace of mind, and if you're in an ARM, it may help you too.
Most counties allow you to dig around in their public records for free. So if you don't have the closing documents that you signed when you bought or refinanced your home, don't worry, your Deed of Trust is probably available online. (What did we do without the Intertubes???) If you happen to live in Pierce County, you can find the recording department at: http://bit.ly/95I2hU Accept the disclaimer and you're in. Search by Lastname, Firstname and set the document type to "Deed of Trust". If you've had multiple homes, or have refinanced multiple times, finding the correct one may be a bit of a challenge, but think about the date you closed and find the one closest to that date. If you have two mortgages, even if they're with the same company, you'll have two deeds of trust.
Once you've located it, your deed of Trust will have what's called an "Adjustable Rate Rider" attached to it. This is the document that determines how often, how much and when your interest rate can adjust. The first thing you'll see is the "Interest Change Dates" this will tell you when your first adjustment is and how often it can adjust after that. For example, mine can adjust June 1st, 2011 and once every 12th month after that. OK, so I know that on June 1st of next year, my first interest rate adjustment can take place. Check.
Next, will be "The Index". This will be the rate they'll be basing your interest rate adjustment on. Mine happens to be the 1 year LIBOR rate. OK, once per year starting June of 2011 and based on the 1 year LIBOR. Got it.
Following the Index will be "Calculation of Changes". This will tell you what they will do to figure out what your new rate will be. In my case they're going to add 2.25% to the Index (1 Year LIBOR) and round it to the nearest .125%. This is where most people start freaking out. Don't worry, that's a normal reaction. But it's not as bad as you might think. See my Interest Only ARM is currently at 5.75%. So a lot of people would think "OH man!! My interest rate is going to go up to EIGHT PERCENT!!" But read it again . . . it's going to go up by 2.25% + The Index. We need to know what the index is. And turns out the index is FAR better now than it was when I closed on my loan. Right now as of today, the 1 year LIBOR is 1.2% Yes, ONE POINT TWO percent. So if we add 2.25% to that, we get 3.45%, but we need to round it to the nearest .125% which gives us an interest rate of 3.5%. So if my rate were to adjust today, it would actually go DOWN 2.25%!!!
But wait, that's not all. My loan was interst only for 5 years, then it re-amortizes over 25 years. So in June of 2011, it will be a 25 year fully amortized loan (Meaning my payments will cover Principle AND Interest) This is a key piece of information to have when recalculating what your payments will change to after the adjustment. If you calculate your payment based on 30 years and it's actually 25 years, you'll get results that will make your payment change look better than it actually is.
As you continue reading your Adjustable Rate Rider, it will give you the maximum and minimum interest rate you can be charged. In my case it's 10.75% (yikes!) and 2.25%. Continuing to read on, it will tell you how much it can adjust in any given period. (Mine is no more than 2%) The first interst rate change (June of 2011 for me) is an exception to this rule. On the first change, it can go up to the top or down to the bottom irregardless of the 2% maximum change rule.
So what does this all mean? Well every situation is going to be different and I'm not giving you advice as to what to do in your particular situation, you'll have to decide that for yourself. But for me, if I gamble and wait for my loan to adjust in June of next year, if rates stay the same (unlikely) as they are today, my payment would only increase by about $70.00/month. If rates went up a full percentage point (Good chance of that happening) my payments will increase by $240.00/month. In a worse case scenario situation, rates went up by as much as 2%, my payment would increase about $428.00/month. In my situation, I'm going to probably ride it out for at least one more year. Because by not paying the extra $400.00/month now, I can put myself in a better situation by this time next year by either saving that $400/month or using it to pay down other consumer debt. Plus, refinancing costs money somewhere, either in closing costs that you pay out of pocket, or add as additional priciple onto the loan. Could be thousands of additional dollars that you have to pay.
If you'd like help evaluating your personal situation, I'm more than happy to sit down with you and discuss your options. If you have any questions about the information I've provided here or how I did my calculations, let me know. Here are some additional resources you may find helpful:
Current LIBOR and other Index Rates
Simple Amortization Calculator
Federal Reserve Board Consumer Handbook on Adjustable Rate Mortgages