Thanks for visiting The Mortgage Reports. To stay absolutely current on mortgage markets and important guideline changes, be sure to take my free daily email alerts.

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.

A few clients called me this week to share concerns about a declining housing market and how it would impact their long-term financial planning.

"I need my home equity for retirement", one said.  "What if foreclosures on my neighbors ruin my nest egg."

Our ensuing conversation covers some basic facts about home equity:

• Home equity is an asset -- just like stocks, bonds, or a stamp collection
• Home equity grows or shrinks as a home's value grows or shrinks
• Home equity grows or shrinks at the same rate, regardless of the mortgage payment, rate, or product
• Home equity tends to represent a disproportionate share of a homeowner's net assets

If you are a homeowner worried about your home equity evaporating in a falling housing market, one realistic solution is to separate the equity from the home via a remortgage.  Then, hand the equity to a financial planner who can invest it somewhere safer than real estate.

Money market fund or basic savings accounts often fit the bill.

An astute observer will recognize that equity separation creates a larger mortgage balance and that may result in a higher monthly payment.

Well, some of my clients have an ingenious way to handle that circumstance: they choose to think of the extra monthly expense as "equity insurance" payments.

I like that idea because it makes complete sense to me -- pay a little more each month in order to preserve the value a large chunk of cash.  Brilliant!

Now, there are also two major benefits to extracting equity that usually get overlooked (so I'll point them out):

1. The dollars you put in the bank account earn interest
2. The dollars you put in the bank account are available in a moment's notice for emergencies

These are two huge deals.  Dollars that are still in the form of "equity" not only earn a 0% interest rate, but aren't available for 2-3 weeks because of the time it takes to remortgage a home (if the bank even approves the application).

And this is what my clients and I review.

Right now, the equity separation wildcard is that tightening lending guidelines are reducing the number of families that are eligible to do it.  So, if you feel at-risk with the amount of equity in your home and want to diversify or add safety to your holdings, call your loan officer and your financial planner for ideas and make a plan.

UPDATE: Mortgage rates for the 15-year fixed mortgage are VERY low versus the 30-year fixed right now. The math no longer works.  Read the update for more information.

For some people, the major financial goal is to pay off the house in full, and bid adieu to the mortgage.  To accomplish that goal, they stuff aside extra payments month after month into the home until the mortgage is paid off.

What a terrible waste of money.

I present a lot of mortgage financing ideas that run contrary to what most folks have always believed, or what they've always been told.  Most of the time, that advice came from parents (who were not sophisticated financiers), or friends (also not confused for Rockefellers).

So, what I will do is show why I am right mathematically.  Math is the only universal truth, no matter what my 12th grade Calculus teacher Mr. Costango says.

We start out with the concept of mortgage interest tax deductions.  This is the domain of tax accountants so I recommend double-checking with your CPA before applying this particular concept to your own life.

Mortgage interest is tax-deductible.  In plain English, deduct the amount of mortgage interest you paid in a year from your actual earned income and that is the amount against which you pay taxes.  Again, talk to your accountant for particulars.

A real example:

$100,000 in annual earnings
- $20,000 in mortgage interest paid
= $80,000 in taxable income

$20,000 in mortgage interest equates to a $5,600 reduction in income taxes for somebody in the 28% tax bracket.

Because mortgage interest is tax-advantaged, we will want to keep the interest as high as possible for as long as we owe money on the house.  This is an important concept and we'll come back to it in a moment.

For now, let's look at the why the 15-year mortgage may not be the best way to pay off your home in 15 years.

In trying to pay down a home rapidly, some folks will want to remortgage their home as a 15-year mortgage.  In a 15-year fixed mortgage, the paydown of principal is fairly rapid.  The yang of that yin is that there is very little mortgage interest paid compared to a 30-year mortgage.

The chart below shows principal paid over time to both mortgages.

In tax terms, the tax advantage of a 15-year fixed mortgage is much less than on a 30-year.  On a hypothetical $200,000 mortgage, interest paid on a 15-year fixed mortgage at 5.50% is $94,150.60 versus $150,636.29 on a 30-year fixed mortgage at 5.75%.  That difference is staggering, and it is usually where people stop on their analysis because they don't consider how mortgage interest can benefit them.

This chart shows the annual interest payments of the two scenarios.

There is also a tax deductibility component of mortgage interest.  For a person in the 33% tax bracket, the savings are as follows:

So, we know that a 15-year mortgage pays off in 15-years.  So, how long does a 30-year mortgage take to pay off?  If you said "30 years", you're right.  But, what if you use the 30-year mortgage amortization, but make extra payments to accelerate the payoff?

The difference in payment between the 15-year and 30-year mortgage is $467 and that represents the monthly cash savings of choosing the 30-year mortgage.  Now, take that money and give it to your financial planner who can earn a conservative rate of return on it.  Let's say 5.00%?  That's pretty fair for when mortgage rates are at 5.50% and 5.75% for 15 years and 30 years, respectively?

If you are disciplined to follow this strategy, you'll notice something interesting begin to happen.  You are -- in essence -- paying a 15-year mortgage.  But, only the 30-year portion is being collected by your mortgage lender.

In other words, you are paying a whole lot of mortgage interest, and putting the "principal portion of your mortgage payment" into a safe account that is earning a rate of return.  The net effect of this is two-fold:

1. You are earning a large amount of tax deductions on your mortgage payments because you are paying your mortgage lender as if you intended to pay off your loan over 30 years, instead of 15
2. You are earning large amounts of compounded interest on your savings account because you are constantly populating it with large chunks of cash

Then, the kicker: Re-invest your "extra" mortgage interest deduction back into your savings account either monthly, or at year-end.  That will boost your savings account even further.

So, what does the math tell us about the fastest way to pay off your home?  Well, we already know how long it takes us to pay off the 15-year mortgage, right?  15 years.

With the 30-year mortgage, something interesting happens.  Remember how we said that in 15 years, we will have paid $150,636.29 in mortgage interest?  I'll tell you this -- it doesn't matter one bit!

The chart below shows the impact of compounded interest on the $467 monthly cash flow savings, and the ever-increasing tax rebate over time (also invested).

It's staring you right in the face but I will bullet point it anyway:

• At Year 15, the total savings account balance is $160,280.38
• At Year 15, the principal balance remaining on the 30-year fixed mortgage (from our amortization chart above) is $140,549.29

Spelled out: the savings account that we so diligently funded with the "extra savings and deductions" from choosing the 30-year mortgage will have earned enough interest to pay off the entire mortgage balance in full in fewer than 15 years!  This is using the power of the mortgage interest tax deduction to its fullest.

The 30-year mortgage becomes a 14-ish year mortgage just by making a portion of your 15-year mortgage payment to your lender, and a portion to your savings account where it can accrue interest and compound.

And, Not only is the 30-year mortgage paid off the loan is fewer than 15 years, but we also gained one very, very important secondary benefit: The savings account money was always available in the event of absolute emergency, no refinance required.

Remember that home equity is not a liquid asset -- it is yours, but you need the bank's permission to borrow it.  If you are paying your mortgage as a 15-year mortgage, all of that principal paydown in tucked away neatly on your balance sheet as equity, but it still belongs to the bank.  If you lost your job (and had no capacity to repay the bank), you would likely be denied access to your equity.

With the 30-year mortgage and separate savings account, you can always access your money if you need it, whenever you need it.  After all, when was the last time a bank denied you access to your checking account?

We can make very similar arguments for the bi-weekly payments of a mortgage, or doubling the principal payments of a mortgage, in order to pay off the home faster.  The concept is the same -- instead of paying the money to your lender, and throwing away tax deductions, maximize your benefits and earn a rate of return on your money.

And, like we said at the beginning, this is blasphemy to a lot of people -- financial planners included.  The math doesn't lie, though.  And neither does the tax code.

Before employing this plan for your own finances, contact your tax adviser and your financial planner.  Call your mortgage banker, even.  Your goal is to balance the requirement to not waste any additional dollars in interest payment and to not waste any mortgage interest tax deductions.

If nobody can help you with the numbers, just call or email me and I'll help you with it.

UPDATE: Mortgage rates for the 15-year fixed mortgage are VERY low versus the 30-year fixed right now. The math no longer works.  Read the update for more information.