If Your ARM Is Adjusting In November 2008 Or In 2009, You May Be A Victim Of Bad Timing

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An adjustable-rate mortgage is a mortgage for which the interest rate remains fixed for some period of time, after which it can change based on some pre-determined rules.

A shared rule among adjustable rate mortgages is the formula by which they adjust. 

Expressed as a formula, it reads:

(Adjusted Rate) = (Variable) + (Constant)

For conforming, full documentation mortgages made since 2003, the variable was often assigned to the 12-month LIBOR, and the constant was often fixed at 2.250.

So, to take the formula and apply it to the real world, the adjusted mortgage rate on a resetting ARM is equal to whatever the 12-month LIBOR is at the time of adjustment, plus 2.250 percent.

As the variable in the equation, of course, LIBOR is of paramount concern to homeowners. 

LIBOR stands for London Interbank Offered Rate, but the acronym doesn't really matter to homeowners with ARMs.  What does matter is that LIBOR is getting slaughtered.

LIBOR is the interest rate at which banks lend money to each other.  And, as banks get munsoned worldwide, financial firms are raising LIBOR to offset the risk of their peers going belly-up.  Since Lehman Brothers failed last month, LIBOR is up nearly 40 percent. 

If you were looking for evidence that banks are nervous about their future, this should do nicely.  Unfortunately, homeowners with ARMs are feeling the pain, too.

• Last Month: A 5-year ARM adjusts to 5.203 percent
• This Month: A 5-year ARM adjusts to 6.308 percent   

Applied to a $300,000 mortgage, LIBOR's rocket-ride drains an additional $2,500 from a household budget over the course of a year.

Until order is restored in global banking system, LIBOR should continue to rise.  This is bad news for homeowners with ARMs adjusting in November, December, or in the early part of 2009.  Mortgage rates will adjust higher, causing pain for homeowners with 2003-vintage, 5-year ARMs at 4.000 percent.

There is some good news, however. 

Mortgage rates on most news loans are lower than what an adjusted mortgage rate would otherwise dictate.  If you have equity in your home and a good credit score, it may be smart to refinance into a brand new mortgage as opposed to letting your existing mortgage adjust.

Contact your mortgage lender to see which plan fits your best.  And, if you can't reach him because he's no longer servicing his clients, know that you're welcome to contact me directly.  My contact information is at right, on top, and I lend in all 50 states.