Tuesday, April 28, 2015 - Article by: Chris Neuswanger - Macro Financial Group -
The turmoil of the world's economy has had one little heralded beneficiary. While governments have teetered on collapse, gold soared and plunged, and oil prices collapsed, the one group who benefited were borrowers whose interest rates were tied to the demand for US Treasury Bills.
The largest single group were homeowners who had adjustable rate mortgages. These loans, while often fixed for the first five or seven years adjust annually thereafter in relation to a set interest rate (often the LIBOR, or London Interbank offering rate) plus a margin or markup between two and three percentage points.
The LIBOR has been below one percent for the last 7 years. This means that millions of mortgage notes have adjusted to sit in the two-three percent range for the next twelve months. This has collectively saved homeowners not only tens of billions of dollars in interest, but in many cases has no doubt literally saved their homes as well, enabling them to afford payments when other household income was reduced, often drastically.
But economics always run in cycles, and history seems bound to repeat itself. What many homeowners have chose to overlook or ignore is the history of the LIBOR rate. While it has been at a record low for the last seven years, history points out that the LIBOR has gone as high as the mid seven percent range on occasion (1999 was the last time) and from 2005-2007 was in the mid five percent range.
What that means is that a mortgage that is tied to the LIBOR plus a margin of 2.5% would have peaked out at nearly ten percent in 1999. The payment on a $300,000 mortgage at 3% is about $1264 per month. At ten percent it would be $2,632/mo.
Adjustable rate mortgages do have caps on how high and how fast they can rise. Generally it is set up as a 5/2/5 cap. What this means is the first time the loan adjusts (often after 5-7 years) the rate cannot go up more than five percent. After that it cannot go up more than two percent above the previous years rate, or a max of five percent over the start rate.
The rate will always adjust annually up or down on the anniversary date of the loan to the selected index plus the margin, subject to the caps.
While I don't think we are going to see a huge jump in the LIBOR rate anytime soon, it will in time probably tick upwards slowly. In the mean time, fixed rates are still at record lows (generally in the high three percent range for a conforming fixed rate) and not that far off of the low adjustable rate many are enjoying. In addition, loan closing costs can often be waived or significantly reduced depending on the particulars of the loan program selected.
If you think you might sell your home in the next few years and have an adjustable rate loan I'd probably suggest you sit tight. If you might stay in your place at least 3-4 years or more and have a adjustable rate loan I'd suggest you consider refinancing into a fixed rate.
However, every borrowers situation is unique, and some thoughtful number crunching is what should come first. We have software programs that are great for running scenarios and helping clients think through their options.
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