Home Mortgage Refinancing Guide

If you used an adjustable rate mortgage to purchase your home or are considering refinancing your existing loan with an Adjustable Rate Mortgage, there are several things you need to know to protect yourself from economic uncertainty. Many homeowners view Adjustable Rate Mortgages as an unnecessary financial risk and avoid them completely. Here are several tips to help you make an informed decision as to which type of loan is right for you before refinancing your home mortgage.

While it’s true that no one can predict or control mortgage interest rates there are steps you can take to protect yourself from uncertain times. This is true if you already have a mortgage with an adjustable interest rate or need to refinance with one to get the lowest possible payment amount.

Many homeowners initially choose Adjustable Rate Mortgages because they need the lowest possible payment. Problems generally arise when the lender begins resetting the loan and the interest rate and payment amount go up. When using an Adjustable Rate Mortgage you always run the risk of payment shock after your loan resets. Payment shock is the risk of waking up one day to find that your loan has reset and the new payment amount is now several hundred dollars higher.

If you are concerned that payment shock could happen with your existing Adjustable Rate Mortgage or the new loan you are considering, there are steps you can take to protect yourself. This allows you to take advantage of the lower introductory mortgage rate while limiting your risk of experiencing payment shock.

Understanding Teaser Rates

Teaser mortgage rates are frequently used as a marketing tactic to attract borrowers. While teaser rates are not necessarily a bad thing as long as you know what you’re getting yourself into, it is important to understand that the teaser rate is not your contract rate. Your contract mortgage rate is the initial interest rate your loan is based on once the teaser expires. When the teaser expires your payment will go up based on this contract interest rate.

Some teaser rates are only valid for 30 or 60 days while others may last for as long as six months. Homeowners who don’t understand how teasers work often find themselves in trouble when the lender resets their loans to this contract mortgage rate. After your teaser expires your loan should remain at the initial contracted rate until your first regularly scheduled reset.

Protecting Yourself When Refinancing

Hybrid Adjustable Rate Mortgages are a special type of mortgage loan that combines the savings of an adjustable rate loan with the stability of a fixed rate mortgage. Hybrid mortgages offer an initial fixed rate period that lasts anywhere from three to ten years and may include an unusually low teaser rate. During this initial period your mortgage rate remains fixed and the payment will not go up. Mortgage rates on hybrid loans are typically lower than traditional 30-year, fixed rate loans without the risk of a standard, Adjustable Rate Mortgage loan.

Homeowners who financed their homes with ultra risky interest-only or option Adjustable Rate Mortgages can take advantage of the Hybrid loan’s fixed rate period to avoid their lenders reset without taking a large jump in their payment amount refinancing with a conventional fixed-rate mortgage loan.

Are All Indexes Created Equal?

Many homeowners obsess over the index their Adjustable Rate Mortgage is based. Every Adjustable Rate Mortgage and Hybrid loan is tied to a financial index that the mortgage interest rate is based on. While it is true that some indexes can experience more volatility than others there isn’t necessarily one index that is better than the others. Common indexes include the Treasure one, two, and three year indexes, the Bank Prime Rate, and the LIBOR (London Inter-Bank Offered Rate).

Many homeowners are surprised to find their mortgages tied to the LIBOR Index; however, the LIBOR is popular because many lenders that sell their loans to European investors. The bottom line when choosing an index for your Adjustable Rate or Hybrid mortgage is that there is no “best” index; you should concentrate on making your decision based on loan terms and interest rates rather than worrying about which index you are getting when shopping for an Adjustable Rate Mortgage.

What About Loan Caps?

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If you are considering refinancing your mortgage with an interest only mortgage there are several things you need to know to minimize your risk and avoid paying too much. When used correctly interest only mortgages can give you a lower monthly payment; however, with any Adjustable Rate Mortgage there is always the risk of payment shock. Here are several tips to help you decide if interest only refinancing is right for your situation.

What Are Interest Only Mortgage Loans?

Interest only loans are a special type of Adjustable Rate Mortgage where your payment is based only on the interest due for a given month. This interest only payment doesn’t last forever; your mortgage lender is going to want their money back eventually. The duration of your interest only period will be specified in your loan contact and typically lasts for five years. At the end of this interest only period your lender will convert your interest only mortgage to a standard Adjustable Rate Mortgage with a payment based on the time remaining in your loan. When this happens your mortgage payments will go up significantly to include loan principal.

Limiting Your Risk With Interest Only Mortgages

There are safety features built into Adjustable Rate Mortgages to protect you from payment shock. Payment shock occurs when an adjustment to your mortgage rate by the lender raises the payment to an amount you can no longer afford. There two types of caps that protect you from a financial crisis. Periodic caps limit the amount your mortgage rate can go up during an adjustment period or over the lifetime of your loan. Payment caps limit the amount your monthly payment can go up or down following an adjustment to your mortgage rate. Your payment cap can also have a lifetime limit.

Beware Negative Amortization

When you borrow with any type of Adjustable Rate Mortgage you have to make sure that you have both types of caps to protect yourself against negative amortization. Mortgage loans that are negatively amortized are actually growing over time as you make your payments. The goal for any type of mortgage is of course to pay the balance off completely so negative amortization is something you should avoid at all costs. You can prevent negative amortization by ensuring your Adjustable Rate Mortgage includes both payment and periodic (interest rate) caps and by avoiding the ultra-risky option Adjustable Rate Mortgage loan.

You can learn more about your interest only mortgage refinancing options, including expensive pitfalls to avoid with a free video tutorial.

I have been answering a number of questions regarding President Bush’s expansion of the FHA loan program with FHA Secure. I’ve decided to consolidate these questions into an FHA Frequently Asked Questions (FAQ) that will be updated frequently as the program develops.

Who is FHASecure Intended to Help?

There are currently just over two million American homeowners with Adjustable Rate Mortgages scheduled to reset over the next four years. The Federal Housing Administration estimates that that this program could help 240,000 homeowners refinance their mortgage loans. If your mortgage is scheduled to reset and you will no longer be able to afford the payments, FHASecure could help you refinance with a government insured, conventional mortgage loan.

How soon can I apply for FHASecure mortgage refinancing?

The Federal Housing Administration began accepting applications on September 5th, 2007 and the program will run through December 31st of 2008.

Do my payments have to be current before I apply?

In order to qualify for FHASecure mortgage refinancing you must pay your mortgage payments on time for six months prior to your Adjustable Rate Mortgage’s scheduled rest. This is not the only requirement, you must be employed and have sufficient income and work history to qualify. FHASecure will charge you a mortgage insurance premium amount based on your credit rating once you’re approved.

What are the requirements for FHASecure mortgage refinancing?

The basic requirements are that you have a non FHA mortgage that has already reset or is scheduled to be reset. You must show that prior to the reset you were making your mortgage payments on time for at least six-months prior to your loan’s reset. There are provisions for homeowners who have missed payments or have poor credit if they have built up enough equity in their homes to qualify. “Reset” means that your lender will be adjusting your mortgage rate and raising your mortgage payment.

Can interest-only and option Adjustable Rate Mortgages be refinanced under FHASecure?

Yes, any Adjustable Rate Mortgage as long as it is not an FHA insured loan can be refinanced with FHASecure. Fixed rate mortgages are currently not eligible for the program but could be added at a later date.

If I’m not behind on my payments can I still refinance with FHASecure?

FHASecure is intended for homeowners that are behind on their mortgage payments because of a scheduled interest rate adjustment on their loans. If you’re not behind on your mortgage payment you could still benefit from a standard FHA mortgage which could get you a lower mortgage interest rate.

What is the maximum I can borrow with an FHASecure loan?

The amount borrowed cannot exceed the conforming loan limits set by Fannie Mae. In 2007 this amount is $417,000.

Can I take out an interest only or option Adjustable Rate Mortgage with an FHASecure Loan?

No. The FHA will not insure interest only or payment option Adjustable Rate Mortgages..and they probably never will due to the risks associated with these Adjsutable Rate Mortgages.

What are FHASecure Mortgage Insurance premiums?

When you take out an FHASecure mortgage loan you will be charged a monthly mortgage insurance premium. This mortgage insurance reduces the risk for the Federal Housing Administration allowing the agency to cover homeowners with poor credit. The amount you pay for your mortgage insurance premium depends on your credit. Homeowners with poor credit will pay more than homeowners with good credit.

If you would like to read more refinancing advice, please register for our free mortgage refinancing blueprint.

If you’re concerned about your mortgage payment amount when the lender resets your Adjustable Rate Mortgage, there are several ways to protect yourself from payment shock. What is payment shock? Imagine waking up one day to a statement from your mortgage lender showing that your payment amount has gone up $650 and you can no longer afford the payments. For many homeowners living paycheck to paycheck this would be a financial disaster that would result in losing their homes. Here are several tips to help protect you from payment shock with your Adjustable Rate Mortgage.

When used correctly Adjustable Rate Mortgages can save you a lot of money. There are risks mainly that your lender will reset the loan and you will no longer be able to afford your payments. What happens when your introductory period ends is that the lender adjusts your interest rate to the index your loan is tied to plus margin. The margin is the markup your lender adds to make a profit. If your Adjustable Rate Mortgage started with a lower “teaser” rate, you could see your payment go up dramatically in a short period of time.

Hybrid Adjustable Rate Mortgages are especially vulnerable to payment shock because of their extended fixed rate period. This fixed introductory period can last as long as five to seven years and many homeowners forget their payments will be adjusted until the bill arrives. Some hybrids adjust every six to twelve months after the initial reset which could wreak havoc on your monthly budget. If your hybrid is due to reset you might consider refinancing before your payment goes up.

Here’s an example to illustrate how people get into trouble with the teaser mortgage rates you see advertised with Adjustable Rate Mortgages. Suppose you refinanced you mortgage using a $200,000 Adjustable Rate Mortgage for 30 years with a 4.0% teaser rate. The fully indexed rate in your loan contract is 6.0%. During the first year under the teaser rate your monthly payment would be $955. When your introductory period ends and the lender resets your mortgage to the contract rate of 6.0% your payment will jump to $1,193. This is assumes the index rate stays below the contract rate; what would happen if your index rate jumped to 7.0 percent? If the index that your mortgage is tied to rises just one percentage point your monthly payment would jump to $1,321. That’s almost $370 higher!

Beware Option Adjustable Rate Mortgages

There are a number of risks associated with the so called “payment option” mortgage if you’ve been making the minimum payment. The minimum payment amount does not cover all of the interest due for a given month; this unpaid interest is added to your loan balance. After a period of time specified in your loan contract, typically five years, or when you reach 125% of your original loan balance due to negative amortization, the lender will recast your loan. When this happens your mortgage is converted to a standard Adjustable Rate Mortgage amortized for the time remaining in your term length…your payments will go up sharply, doubly so if interest rates have risen.

If you have an Adjustable Rate Mortgage on your home it is extremely important to find out when your loan is scheduled to reset. Here are several steps you can take to protect yourself from payment shock when this reset happens:

Refinance Your Mortgage

Refinance with a fixed rate loan before your loan resets; your monthly payment amount may go up with a fixed mortgage rate; however, you will be protected from future interest rate hikes. Make sure your mortgage does not have a prepayment penalty and determine if the fees you will pay for the new loan make refinancing worthwhile. Refinancing is a good option for homeowners that plan to keep their homes for a long time.

Save for a Rainy Day

If you can make a large payment to your mortgage principal when your loan resets, this will lessen the effect of the higher mortgage rate. Make sure that your loan contract does not include a prepayment penalty that prevents your from making large principal payments.

Avoid Optional Minimum Payments

If you’ve been making the minimum payment on an option mortgage, start making a fully amortized payment. This will reduce your loan balance before the lender recasts your mortgage. If that’s not an option due to budget restraints try and make the interest only payment to prevent negative amortization on your loan.

You can learn more about your mortgage options including costly pitfalls to avoid by registering for this free Mortgage Refinancing Blueprint.

Interest-only mortgage loans are a source of confusion for many homeowners. If you need the lowest possible payment while minimizing your risk of payment shock, an interest-only mortgage could be your answer. Here are the basics you need to understand about interest-only Adjustable Rate Mortgages (ARM) to make an informed decision and minimize your risk when refinancing.

Adjustable Rate Mortgages 101

What are Adjustable Rate Mortgages and how do they differ from a conventional fixed interest rate loans? Adjustable Rate Mortgages are simply mortgage loans that have a variable interest rate that changes over time. How often your mortgage rate changes depends on the lender and the type of Adjustable Rate Mortgage you’ve chosen; however, every 24 months is a common adjustment period.

What happens when your lender adjusts your mortgage rate? When your mortgage lender adjusts the interest rate they will change your rate to whatever index your loan is tied to plus the lender’s margin. The margin your lender adds is their markup to cover expenses and profit on your loan. When shopping for an Adjustable Rate Mortgage the lender’s margin is an important consideration to make when choosing a loan offer.

What is an index? The index determines your base mortgage rate. Key financial indexes commonly used by mortgage lenders include the Prime Rate, the LIBOR (London InterBank Offered Rate…lenders like this one because they can sell loans tied to the LIBOR to European investors), and the Treasury Index. These interest rates rise and fall based on the supply and demand of credit and other economic factors.

Adjustable Rate Mortgage Features

If you are in the market for an Adjustable Rate Mortgage there are three loan features you need to look at in the offers you consider. These features are the index, margin, and caps. We’ve already discussed index and margin; caps are safety features used to minimize your risk of payment shock when refinancing with an Adjustable Rate Mortgage.

What is payment shock? Imagine waking up one day to a statement from your lender showing that your mortgage rate has gone from 7.5% to 10.5% and your new payment amount will be $700 higher. Fortunately, Adjustable Rate Mortgage loans have built in safety features to protect your from a nightmare like this.

Caps are Adjustable Rate Mortgage safety features that can protect you from payment shock when structured correctly. There are two varieties of caps and you need to make sure your Adjustable Rate Mortgage comes with both types. The first type of cap is called a periodic, or interest rate cap. This cap limits how much your lender can adjust your interest rate up or down during an adjustment period. The second type is payment cap that limits how much your lender can raise or lower your monthly payment during an adjustment period. Both types of caps an have a lifetime cap meaning that the total changes, up or down, are limited over the duration of your loan.

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