5 mortgage moves for 2008

Knowing when and how your adjustable-rate mortgage will reset to a higher interest rate should be your first priority. It can help you determine whether -- and when -- refinancing is the right move.

Published by Bankrate.com on 2/19/08


In 2003, when mortgage rates dropped below 5.5% for a time, it was the Year of the Refinance. The years 2004 through 2006 constituted the Era of the Exotic Mortgage, when home buyers were eager to get any type of loan so they could grab houses before prices were out of reach. Then came 2007, the Year of Reckoning, when home prices went down and the foreclosure rate went up.

And 2008 will be the Year of the Refinance again, but for different reasons than those that drove the refi boom of 2003. Five years ago, low rates spurred people to refinance. In 2008, homeowners will refi because their adjustable-rate mortgages will hit their reset dates, sending rates skyward.

Know when your ARM resets

It's bad form to get caught by surprise when your adjustable-rate mortgage, or ARM, resets. Here's how to not let it happen to you.

First, you have to know what "reset" means. By definition, the rate on an adjustable-rate mortgage goes through at least one adjustment. Those adjustments are called resets. In recent years, the most common kinds of adjustables have been 3/1 and 5/1 ARMs.

With a 3/1 ARM, the initial, introductory rate lasts three years. Then, on the 37th month, the loan is reset for the first time and the rate is adjusted. Typically the rate is reset every 12 months after that. With a 5/1 ARM, the introductory rate lasts for five years and the first reset is at the 61st month.

To check on the reset date, pull out your copy of the loan contract from your well-organized home filing system. On the first two or three pages, there should be a section that details when the rate changes and how the new rate is determined. Look for a little headline that says something like, "Change dates."

The first reset date, and the timetable for subsequent resets, should be in that section.

Find out what your ARM's rate would be if it were reset this month

Just so you'll have an inkling of what you'll be facing, find out what would happen if the rate were to reset now. This step isn't necessary if the reset is a long way off. But if the rate is going to change in 2008, this is something to keep an eye on.

Go back to that loan contract. In the section that discloses the rate's change date, there should be an explanation of how the lender will calculate the new rate. The ARM's rate will be based on an index and a margin. The index is an independent interest rate that is widely known -- the yield on the one-year Treasury note, for example, or the six-month London Interbank Offered Rate (LIBOR).

The margin is a percentage that's added to the index. Let's say that your index is the one-year LIBOR, and that today it's exactly 5%. (It's not; we're just being hypothetical here.) And let's say your margin is 2.25%. If your ARM were to reset today, the new rate would be those numbers added together, or 7.25%.

The margin will be stated right there in the loan paperwork, although it might not use the word "margin" to describe it. As for the index, you can find many indexes online or in the business section of a newspaper.

Once you know the new rate and the amount you owe, figure your monthly principal and interest with an online mortgage calculator.

Home Affordability Calculator Yearly gross income $
Monthly debt payments $
Cash avail. for purchase $

Know if you should refinance sooner rather than later

To refinance, your house has to be worth more than the amount of the refinanced loan. Your equity is the difference between the house's market value and the amount you owe. If the house is worth $200,000 today and you owe $180,000, that $20,000 difference is the equity. With a $200,000 house, that would be 10% equity.

The more equity you have, the easier it's going to be to refinance. If you have less than 5% equity, it might be difficult to qualify for a refinanced mortgage. Difficult, but not impossible -- if you have a decent credit score. Preferably, you will have 10% equity; ideally, you'll have 20% or more. If your home has been losing value in this down market, you probably are aware of it from reading the newspapers, gossiping with neighbors and occasionally checking Zillow.com. In cases where the percentage of equity is in the single digits while home prices are falling, it might be a good idea to refinance months before the reset date. Wait too long and you might not be able to refi because you owe more than the house is worth.

Get ready to document your finances

During the housing boom, many home buyers eagerly got low-documentation and no-documentation (low-doc and no-doc) mortgages, in which they stated their incomes and assets, but didn't have to provide paperwork to document their personal finances.

Experts believe that most of these borrowers exaggerated their incomes because that was the only way they could get approved for their loans. Had they been required to submit W-2s and tax returns, they would have been turned down for loans because of insufficient income.

In 2007, the rising foreclosure rate was blamed partly on these borrowers. Most of them got ARMs, and they were able to scrape by and make their monthly payments during the introductory rate period. But when the ARMs reset, these borrowers found themselves falling behind. That trend will continue in 2008.

Spurred by self-preservation, lenders have cracked down, and now they're demanding documentation of income and assets from most borrowers. Don't be surprised if a lender wants not only W-2s and tax returns, but also bank and brokerage statements.

If you lied about your income to qualify for an ARM and now you can't refinance because of documentation requirements, you're not going to get any sympathy. When you signed the promissory note, you swore under penalty of perjury that you were telling the truth.

Buying? Bring a down payment

House prices are falling in many major markets. Your lender doesn't want to give you a big pile of money for a house that's going to be worth less than the loan balance in a few months. So your lender is going to want a cushion. The down payment is that cushion.

During the boom years, it was easy to buy a house with a down payment of 5% or 3% or even with no down payment at all. Those deals aren't as common anymore.

"I think we're going back to where 10% is going to be the standard for a down payment," says Mitch Ohlbaum, president of Legend Mortgage Corp., in Los Angeles.


What are your experiences?