A rate reset on an adjustable-rate mortgage (ARM) can be stressful. But thanks to historically low interest rates, there's a good chance your rate will actually go down if it's scheduled to reset in the next few months. If that's the case, you might be better off sticking with your ARM a little longer, despite the low rates on fixed-rate mortgages (FRMs).
Interest rates on ARMs typically are calculated by adding percentage points to a rate index -- most commonly the 12-month London Interbank Offered Rate, or LIBOR. The rate index fluctuates, and the margin between your rate and the rate index is set by the lender and remains fixed for the life of your loan. The margin is often 2.75%, but can be higher if your lender considers you a risky borrower.
The 12-month LIBOR has fluctuated widely over the past decade -- it was at a low of roughly 1% in 2004 before rising steadily to more than 5% by the end of 2007. Now with LIBOR back to the 2% mark, borrowers with ARMs are potentially facing a drop in their interest rates.
For example, say your mortgage rate is scheduled to reset in March, and you're deciding between refinancing with a new FRM and letting your rate reset. Your current interest rate is around 5%, and you have $200,000 remaining on your initial mortgage. The margin on your ARM is 2.75%, so with the 12-month LIBOR roughly 2%, your rate would drop to 4.75%. That means your monthly payments, which are now $1,169, will likely be reduced to $1,140. BankingMyWay.com's ARM calculator can show how your specific numbers might change.)