What to Do When Your Mortgage Rate Changes

WASHINGTON â€”  One of the most worrisome moments in a homeowner’s tenure is when the rate on his adjustable mortgage is about to change.

Borrowers with fixed mortgages don’t have to worry about that. Their rates never change, so their payments for principal and interest never vary. Their payments will go up if their property taxes increase or if their hazard insurance premiums rise. But the PI part of their PITI--principal, interest, taxes and insurance--payment will always remain the same.

However, borrowers who chose an adjustable-rate mortgage in return for a lower starting rate often feel trepidation that when the moment of truth presents itself.

If you are among those borrowers, a rate adjustment is probably the last thing you want to see. But it still shouldn’t catch you off guard. Your lender will remind you plenty of time beforehand. And you’ll have an opportunity to weigh your options, which may be more numerous than you think.

Lenders don’t send a letter warning borrowers to expect an adjustment. But by law, they are required to give you at least 25 business days’ notice of what changes, if any, will take place. And some give you even more time to decide how to proceed.

According to Roxanne Bostin at First Nationwide Mortgage, a Frederick, Md., lender that administers a portfolio of 150,000 adjustable mortgages, the typical “look back� notice is mailed 45 business days before an adjustment. But some of the loans her company services call for notices to be sent 120 days in advance of changes. Your loan documents will specify when you should expect to be notified.

Even if you receive only a 25-day warning, five workweeks is plenty of time to make a decision.

The adjustment notice should contain: the date your payment will change, the old and new index rate, the lender’s margin or markup, the old loan rate and the new one, and the old and new principal and interest payment.

The first thing you should do is check to make sure the proper index, the correct index amount and the appropriate index period were used in calculating your adjustment. Make sure the lender has the right starting rate and that the margin amount hasn’t changed. ll this information can be found in your mortgage. It’s also a good idea to check the lender’s math.

Generally, if this is your first adjustment, you can expect your rate and payment to rise. Subsequent changes will follow the market. Usually, but not always, the initial adjustment is an increase, says Frank Nothaft, deputy chief economist at Freddie Mac, a major supplier of funds for home loans.

Why? Because your original rate was a discounted one, somewhat below the index used to track market rates at the time the loan was made. Now, with the first adjustment, your lender gets to make up that difference.

Consequently, even if there has been no change in market rates, you can expect your rate to rise. Even if rates have declined since you first took out the loan, the drop would have to be greater than the initial discount to prevent your rate and payment from going up.

This is why lenders tend to see a spike in their prepayment rates about the time of the first anniversary of their adjustable rate mortgages. People are bailing out by paying off their ARMs and switching to either fixed-rate loans or another adjustable with a lower starting rate.

Refinancing is certainly an option, but it’s not your only one. It might even be wiser to stick with what you now have.

Tom Ward of Majestic Mortgage in Mundelein, Ill., is a “let it ride� advocate under current market conditions for a couple of reasons. First, in almost all cases, ARMs adjustments are limited to protect borrowers from payment shock as the result of a big jump in mortgage rates. And second, a loan can adjust down as well as up.

Nowadays, most adjustables limit the amount your rate can increase at any one time to no more than 2%. Moreover, increases are normally capped at no more than 6% over the life of the loan. So, if your original rate was 6%, the highest it could go at the first adjustment is 8%. And it could never go any higher than 12%.

In Ward’s experience, though, many people believe the mortgage rate rides the cap; that is, they believe that if the cap is 2 percentage points, then the interest rate automatically rises 2 percentage points. But that’s just not the case.

The key is the index, which is based on short-term rates. Whereas mortgage rates are long-term rates that are not directly affected by actions taken by the Federal Reserve, short-term rates move almost in concert with any Fed cuts. . And there have been nine of them so far this year, with the possibility of another one soon.

The most common index for ARMs is the one-year Treasury bill, which has fallen considerably since January, when the Fed began slicing into the rate banks are allowed to charge one another for overnight loans. And that brings us to something ARMs borrowers either tend to forget or never understood in the first place: Their rates can go down.

Another option is to ask your current lender what he might do for you to keep you from turning in your ARM and taking your business elsewhere. To keep their best customers--those who pay on time each and every month--First Nationwide and others are offering to modify loans at little or no cost.

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Lew Sichelman is a real estate columnist. He can be contacted at [email protected]. Distributed by United Feature Syndicate.