Bailout Affects ARM Refinance

Added December 1, 2008 by Ilyce R. Glink

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Summary: How has the recent credit crisis and bailout affected mortgage interest rates? To decide whether to refinance an adjustable rate mortgage into a fixed rate loan you need to understand which index your lender uses to set the ARM interest rate. ARMs are often tied to the London InterBank Offered Rate (LIBOR) or U.S. Treasury bills. These indexes may move in different directions and so you may want to refinance in one case but not the other. When you know which index affects your mortgage loan you will have a better idea of mortgage interest rates.

Q: I currently have a 5/1 adjustable rate mortgage (ARM) that is due to reset in February. I want to refinance the loan into a 15-year fixed-rate mortgage before then. In lieu of the recent credit crisis and 'bailout' package, what can I expect to happen to interest rates?

A: Depending on what index your mortgage interest rate is tied to, you might find that the interest rate on your loan will either stay about the same or go down.

If the loan is tied to U.S. Treasuries, it would seem that the interest rate would probably stay the same or go down (where it will stay for another year). However, if the loan is tied to LIBOR (London Inter-Bank Offered Rate), then it might go up.

You should check to see what the index is that the loan is tied to and then try to figure out what is the margin that is tacked on to come up with your rate. If you can't figure this out, call your lender or loan servicer (the toll-free number should be on your statement) to get this information.

How To Calculate Your ARM Interest Rate Once you see where your rate will be, you can make a decision about what to do. To determine where your rate will end up when it adjusts, you need to keep a couple of things in mind. Even if your rate is tied to the U.S. Treasuries or LIBOR, your loan should have a margin amount. That margin amount is the amount they add to the Treasury rate or LIBOR rate to get the actual interest rate that you will end up paying.

That is to say, if the Treasury rate is 1 percent and your margin rate on your loan is 3 percent, the rate you should pay for the next year on your loan is 4 percent. However, many ARM loans also have other caps. These caps in many cases limit the increases or decreases in the interest rate on your loan. If the rate on your loan is currently 7 percent, and your annual increase/decrease cap is 2 percent, your rate could only go down to 5 percent. However, if your current rate is 5 percent, you could see your interest rate drop to 4 percent.

Frequently, your bank should be able to tell you what your new interest rate will be 45 days prior to the date in which your new loan payment amount would be due. If the loan is going to stay the same or go down, I wouldn't necessarily rush to refinance.

I think that mortgage interest rates will eventually have to fall in order to kick start the housing market. They're too high at the moment to stimulate the housing market the way that they should. I think that the government will have to step in and artificially deflate the rates by perhaps funding loans purchased by Fannie Mae and Freddie Mac directly. If they do this, instead of relying on the bond market, then they can set interest rates wherever they want.

When that happens, and I believe it will, I think you should take advantage and refinance.

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