Do You Have an Adjustable Rate Mortgage?

You've had Plenty of Time to Convert

I must speak my piece concerning homeowners who are facing rising rates and higher monthly payments as their adjustable rate mortgages are reset. We have heard many stories of American families' who are shocked and surprised when they receive their notice of rate increases in the mail from their lender.

I have two main concerns for these individuals:

First, when you took out the loan did you not understand that an adjustable rate mortgage means just that -- the rate can adjust? Second, did you not hear, see or watch any of the profuse news stories broadcast and published about the Federal Reserve's intention to steadily raise rates, which began in 2004?

Now, I'm in no way excusing unethical or illegal activities on the part of some bad apples in the mortgage business. If a borrower was duped into taking out an ARM by unethical tactics used by the loan officer, these individuals need to be investigated. The fact is that mortgage lenders and brokers are regulated by most states and all are required by federal law to disclose the terms of an ARM. For the last 10 years I have owned a mortgage company, and I have great contempt for the relatively few loan officers who use unethical tactics to dupe unsuspecting borrowers into bad mortgage products. But it would be unreasonable to assume that all homeowners carrying ARMs were deceived into taking a bad mortgage. In reality, ARMs were very attractive for many years, beginning in 2001. And when they started to rise, any ARM holder should have seen it coming.

Let's take a look at some history. In the months before the 9/11 attacks, the Federal Reserve was lowering rates in small increments to spur an economy that was showing signs of anemia. When 9/11 hit, Fed Chairman Alan Greenspan made no secret of his intention to continue to lower rates. These are short term interest rates, folks -- the same kind that determine adjustable rate mortgages.

Adjustable rates plunged from 2001 through 2003. At the time, a monthly ARM was available with no points at about four percent while 30 year fixed rates were hovering around 7.25 percent. That's a big spread. Since adjustable rate mortgages tend to follow the short term rates governed by the Fed, it was pretty easy to make a good bet where these ARMs were headed, because the Fed was very clear about their monetary policy.

By mid 2004 the Fed began nudging rates up. It made no secret of their plan to raise rates at a "measured" pace. In other words, ARM holders had plenty of time to get out of the still-rock-bottom ARM into a fixed rate, which were still below six percent at the time. The problem is that while fixed rates may have been in the high five's, ARM holders were still paying rates in the mid-fours. Many ARM holders resisted the idea of fixing their rate near six percent while their current rate was so much lower. Many ARM holders clearly ignored the blatant warnings by the Fed that it would be continuing to raise short term rates.

Short term rates shot up considerably in 2005, with most indices increasing by two percent or more. Luckily, though, long term rates continue to move up at a much slower pace, suggesting that current ARM holders haven't totally missed the boat.

As you may have notice in some of my previous articles, adjustable rate mortgages are not my favorite loan programs. They simply are not for everyone. So what's an ARM holder to do today? My recommendation is to get out, despite the mild up tick in fixed rates. Today, most ARM holders are facing fully indexed rates between 7.25 and 8.50 percent, depending on the index and margin. Fixed rates are hovering between 5.75% and 6.0% with little or no closing costs, depending on the situation. There's no reason not to grab the insurance policy of a fixed rate.