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?
Adjustable Rate and Hybrid Mortgages come with built-in safety features known as caps. Caps limit the amount your mortgage interest rate and payment can change with the lender resets your loan and over the lifetime of your mortgage. Caps come in two varieties. There are payment caps that limit the amount your payment can go up or down during an individual adjustment or over the lifetime of the mortgage, and periodic caps that limit how much your mortgage rate can go up or down during any adjustment or over the lifetime of the mortgage.
It is important to ensure that your Adjustable Rate or Hybrid mortgage has both payment and periodic caps with lifetime limits. Your mortgage lender may not offer both types of caps with a lifetime limit unless you ask, and loans that do not have properly structured caps may be prone to negative amortization. This is a generally undesirable condition where your mortgage actually grows over time rather than gradually being paid down.
Adjustable Rate Mortgages and Yield Spread Premium
When refinancing your home with an Adjustable Rate or Hybrid mortgage you still need to be concerned about paying Yield Spread Premium. If you’re not already familiar with Yield Spread Premium this is the unnecessary markup added to your mortgage interest rate to give your broker a commission. Yield Spread Premium is unnecessary because you’re already paying a commission to the broker in the form of an origination fee. Any amount of Yield Spread Premium that you agree to pay could raise your monthly payment amount by hundreds of dollars. Fortunately for you, homeowners who understand how Yield Spread Premium works can avoid this markup and take advantage of wholesale mortgage rates.
How You Can Avoid Yield Spread Premium
You can avoid this unnecessary markup of your mortgage interest rate by negotiating with potential mortgage brokers for a loan that does not include the markup. Start by telling them that you understand how Yield Spread Premium works and will not consider loan offers that include this markup. Offer to pay your mortgage broker a reasonable origination fee of one percent for their services. If the mortgage broker refuses to negotiate over Yield Spread Premium simply move on to the next broker. You may have better luck negotiating with a mortgage broker that is self-employed rather than one that works for a large brokerage house.
You can learn more about your Adjustable Rate Mortgage options, including strategies for refinancing your loan with a wholesale mortgage rate while avoiding junk fees with this free mortgage tutorial.