Are ARMs Dead?

Maybe.

Data compiled by MortgageDataWeb.com, a Virginia-based marketing firm for the real estate industry supports this. The number of newly-originated ARMs is down, but so is the number of new mortgage originations of all types–from 322,390 in May 2005 to only 77,222 in November 2009. However, the number of ARM originations has plunged like a Hummer off a cliff–from 146,852 in May 2005 to a paltry 2,225 in December 2009.

Five years ago, in March 2005, 45.75% of all purchase home loans were ARMs. But by December 2007, only 7.21% of all new mortgages were, and that share hasn’t exceed 9.0% in any month since then. ARM originations hit a low of 2.85% in February 2009 before bouncing back at the end the year to 4.52%.

ARMs are no longer a popular refinance vehicle either–the number of homeowners seeking an ARM mortgage refinance has deflated from over 60% in early 2005 to less than 1% at the end of 2009, even though mortgage lenders were offering 5/1 ARMs (fixed for five years, and adjustable annually thereafter) at rates as low as 3.25% to highly-qualified borrowers.

ARMs Are Still a Viable Choice for Many

According to Pew Research, 63% of people do not remain in their home towns, most frequently citing economic opportunity as the reason for moving. And the more educated or affluent you become, the more likely it is that you will move. Furthermore, younger people may change houses even if they stay in the same community–as they start families or earn more, many desire a change of address as well. So if the odds are that you’re going to change homes in the next five years or so, why not opt for a hybrid ARM and save a full percent on your interest rate?

How Much Can You Save?

On a $350,000 mortgage, the difference between a 4% mortgage and a 5% mortgage is $208 a month. Over a five year period, that’s $12,480–a good start on your future kid’s college fund!

In mortgage lending, there’s no one-size-fits all home loan. Make sure your lender considers your unique situation when making recommendations.

First, Look at the Terms of Your ARM

Your paperwork should contain an ARM rider that should give you these pieces of information: Your start rate, your index, your margin, and any rate or adjustment caps and floors. For example, you might have a 3/1 ARM with a start rate of 4%, based on the 1-year LIBOR index, with a margin of 2%, annual adjustments capped at 2%, a lifetime cap of 10%, and a floor of 3%. Your 4% mortgage is set to adjust in a month; what will it do?

Check Your Index

You can find index data on most financial Web sites. The 1-year LIBOR index as of February 2010 is .85158. If your mortgage were adjusting today, you’d add your margin of 2% and get a rate of 2.852%!

Check Your Caps and Floors

But wait, there’s more. Your loan has a floor of 3%, which means that your rate can’t drop below 3% no matter what the LIBOR does. So you’d be at 3%, which isn’t bad. And that 3% is your best case scenario. So what’s your worst-case scenario? Check your caps–your rate can’t increase more than 2% per year. So, if you adjusted to a 3% rate next month, in a year the highest your rate could be go would be to 5%, then the following year to 7%, then 9%, then it would top out at 10% and stay there. So much for worst case.

What’s More Likely?

Best and worst case scenarios are extremes and unlikely to resemble the progress of your actual loan, especially over the long term. But you can predict a more likely and reasonable course for your mortgage. Here’s how: a search of “historical average 1 year LIBOR” online gets me the data I want. I dump it into a spreadsheet and I discover that the average of the 1-year LIBOR since its inception in 1990 is 4.623%. So we can add that to your margin of 2% for a total of 6.623%.

Yes, I could be a statistical stinker and make you calculate the expected value, but an average is a fairly good substitute and no one ever committed suicide trying to calculate an average. It’s a fairly safe bet, then, that your loan will adjust to 3% next month, 5% the following year, and then it may fluctuate around that 6.623% rate over the years–there’s no guaranty, but the longer you have your loan, the more likely it is that your rate will behave itself.

So, Should You Fix Your Interest Rate or Not?

That depends. Fixed rates today are about 5% if you have good credit–less than the average LIBOR ARM rate of 6.623%. You’d probably save money in the long run by refinancing. But what if you’re not in it for the long haul? If this house is a starter, or you have job transfers every five years or so, leaving your ARM alone is probably a safe bet. You know your rate won’t exceed 7% for at least three years.

How Underwriters Look at Mortgage Refinances for Self Employed Borrowers

Look at your tax return (the one you are preparing for 2009). To do a quick and dirty income check, you can use Fannie Mae’s Self-Employed Income Analysis form, which is available online if you want to give your income a test run.

If that doesn’t give you enough income to qualify, you can also use corporate or partnership income to qualify–if you can prove that you’re legally entitled to the income and that you have access to it.

Don’t Count Your Expenses Twice

This happens more often than you’d expect. If you have a payment that shows up on your personal credit report, for example you have a company car lease–an underwriter and most automated systems will count that payment in your debts. However, if you are already deducting it from your business income, treating it that way overstates your expenses. Go through your credit report carefully and note every expense that is used for business and deducted from your income. It makes a big difference.

Consider Your Home Equity Position

Most stated income mortgages taken in the last few years did require significant down payments. If you are lucky enough to have excellent credit and a large equity position, you may be approved for a loan even if your debt-to-income ratios are a bit high. Try a conventional or FHA lender and see–automated underwriting systems can tell you almost instantly if you get an approval or not.

Get A Little Help with Your Mortgage Refinance

Other options include bringing in a co-borrower or co-signor. Additional verifiable income could qualify you for a traditional loan.

Try a Mortgage Broker

Stated income financing is not totally dead. Brokers have financing available–either stated income products or loans that allow you to prove your income with bank statements showing your cash flows. A quick check shows there are stated income 3/1 hybrid ARMs out there at 6.25%, assuming that your credit, assets, and equity is sufficient to qualify.

• Own a one- to four-unit home
• Have a mortgage that is owned or guaranteed by Freddie Mac or Fannie Mae
• Have made no late mortgage payments (more than 30 days late) in the last twelve months
• Owe no more than 125% of the value of your home (on the first mortgage–if the holder of the second lien subordinates its loan, the combined loan to value can be higher).

Call your Fannie Mae or Freddie Mac loan servicer about a HARP refinance if you meet these criteria. Only your servicer can tell for sure if you’re eligible.

Refinancing with a New Lender

Check with your current lender about pricing for a HARP mortgage refinance, then compare it to mortgage refinance quotes from other lenders. You can use the lender that provides the best deal, with one caveat: to use a different lender, your application must be scored by an automated underwriting service and approved. If it has to be underwritten manually, only your current lender can fund your refinance.

The other problem you might have with a different lender is mortgage insurance. If you have a mortgage insurance policy now, it can remain in force when you refinance with the same lender. If you change lenders, you have to get a new policy, and that can be problematic at high loan-to-value ratios.

Benefits of HARP Refinancing

A HARP mortgage refinance has several advantages over a regular refinance these days.

• If you don’t have mortgage insurance on your current mortgage, you won’t be required to add it, even if your equity is less than 20%.
• If you have a mortgage insurance policy, you won’t be required to add extra coverage even if your equity has decreased.
• Loan level pricing adjustments (LLPAs) are limited to two points, so if your credit score is on the low side you aren’t penalized. Without this cap your fees could easily add up to five points or even more.
• Unlike traditional refinances, you may be allowed to refinance a home that is or has recently been listed for sale.

Check with your current mortgage servicer about your HARP eligibility, shop for the best rate, then apply for your refinance and start saving money.

If You Are Fast and Furious with Credit, Expect to Pay More for a Mortgage Refinance

If you’re as careful with your money as a stunt driver is with his femurs, your FICO score will reflect it–and you’ll pay a surcharge for your next home loan. How much can a single indiscretion cost? A lot. According to Fair Isaac, the company that owns the FICO credit scoring model, a person with a 680 credit score who misses a single payment (pays more than 30 days late) will take a 60 to 80 point hit. What does that do to the cost of your mortgage? Let’s ask Fannie Mae.

Fannie Mae’s Loan Level Pricing Adjustment Matrix (aka, the Chart of Doom)

If you have a strong heart, take a look at this little chart of Fannie Mae’s (and yes, Freddie Mac has one, too). Before you messed up and missed a payment, your 680 credit score was good enough to get you a an 85% refinance with total surcharges of 1.375%–a 1% charge for a credit score less than 720, a .250% adverse market delivery charge, and a .125% minimum mortgage insurance charge. But once that late payment hits, your score drops to between 600 and 620. Assuming that it only drops to 620, your increased costs are as follows: You still have the adverse market delivery charge, but your credit score surcharge increases to a whopping 3%, and your MI charge increases to 1.75%, for a grand total of 5% in fees. On a $400,000 mortgage, that single late payment could cost you an extra $14,500 (that’s 5% - 1.375% * 400,000)!

So, if you’re thinking about refinancing a mortgage, check your credit first. You can get a report for free, but spend a little extra to get your scores too. Then you’ll know if a refinance today is a smart decision, or if you need to pay your bills on time for a few months and get your credit score back up.

Debt Management Techniques

Debt management usually involves making a monthly payment to a debt management or credit counseling company, which then divides the payment between your unsecured creditors each month. A good service should also counsel you about dealing with debt and teach you to budget and spend wisely. In addition, the service should negotiate lower interest rates and payments from your creditors.

Debt Consolidation Loans

A debt consolidation loan can accomplish the same thing–you take a loan (the best interest rates can be found with a home equity mortgage) and pay off your creditors. Then you make a single payment each month until your loan is paid off.

Chapter 13 Bankruptcy Is Debt Management, Too

A Chapter 13 bankruptcy is a debt management plan overseen by a bankruptcy trustee. The court determines what payment is affordable for you and the creditors are forced to accept it. In three to five years, you complete your plan and any remaining obligations are discharged.

What’s the Best Solution?

The best solution depends on a few things–your credit score, your home equity, how stable your income is, and how nice your creditors are willing to be to you.

• Home Equity for Debt Consolidation If you have lots of home equity and decent credit, consolidating debt with a home equity loan can really cut your interest rate. And you won’t incur monthly charges to a management company. But you do want to accelerate the home equity loan’s payoff as much as you can–if you keep that loan for 15 years you could end up paying a lot more in interest. The second home equity consideration is how stable your income is–once you turn unsecured credit card debt into a debt secured by your home, you won’t be able to discharge it with a bankruptcy. If the home equity payment becomes unmake-able, you could lose your home as well.
• Debt Management Solutions A debt management company is a great solution because it includes education. You are better off in the long run if you understand money and how to manage your debts. If shaving a bit off your interest rate and lowering your payment is enough to get you out of trouble, that’s the way to go. Just make sure that your service is reputable and verify how much of your payment is going to the creditors each month. In addition, get a written schedule so you can see how long it will take to repay your debts under the plan.
• Chapter 13 Bankruptcy This is the most drastic solution, but if your creditors aren’t willing to drop your interest rates and payments, a judge can make them. The payment under a Chapter 13 plan may be more manageable than what your creditors want you to pay. In addition, if your income changes, a judge can adjust your payment accordingly. Finally, there is a bright light at the end of that tunnel–as long as you complete your plan as required, your debts are discharged. You’re done in three to five years.

Understand all the solutions available to help you manage your debt problems. Then choose the best one for you.

Your Big Fat Mortgage Refinance

What can you do to get a lower interest rate today on a jumbo mortgage?

First, look up conforming and FHA loan limits in your area. You might be pleasantly surprised. Depending on where you live, you may be able to get a jumbo conforming loan from Fannie or Freddie or an FHA mortgage with a better interest rate. Conforming mortgage limits in higher cost areas range from $721,050 in Honolulu, HI to loans from $426,650 in Providence, RI.

But you should also consider FHA. FHA limits may be higher than conforming limits in some locations. If you live in Alameda County, CA, you can get an FHA loan up to $729,750, but only $625,500 with Fannie Mae. And if you have a duplex, triplex, or fourplex, your limits go way up.

Supersize a Jumbo Hybrid ARM

Jumbo 30-year mortgage rates are so much higher than comparable hybrid ARMs, which may be fixed for three, five, seven, or ten years. On a $625,000 mortgage, you may find a 30-year fixed jumbo interest rate at 6.5%, but a 5/1 hybrid is at only 5.25%. The 5/1 payment is only $3,451, $499 less than the 30-year payment of $3,950. Over a five-year period, you’d save almost $30,000. Or you could put your savings toward principal reduction and lower your mortgage balance by an additional $33,000 over 5 years.

Mortgage Refinancing: Two Loans Are Better than One?

Refinancing one loan with two loans?! Why? You might get a better deal by combining a conforming first mortgage with a second mortgage. Do some calculations to see if this makes sense, for example: a homeowner has a $525,000 jumbo mortgage and lives in Baltimore, where the conforming loan limit is $494,500. With a $494,500 first mortgage at 5% and a second mortgage of $30,500 at 8%, the blended rate is 5.17%.

In addition, home equity lines are typically much cheaper to process than traditional refinances. So if you save a couple of points on $30,500, that’s another $261 for you.

Watch Out for Fees When You Refinance

If you last shopped for a mortgage a couple of years ago, there have been changes. The advertised conforming interest rates you see aren’t always what you get. Fannie Mae and Freddie Mac add risk-based pricing adjustments, and unless you have a lovely credit score and a low loan-to-value ratio, a conforming mortgage rate might not be any better than refinancing a mortgage with a jumbo lender.

Mortgage Modification Might Help

Making Home Affordable modifications are available up to $729,750. If your jumbo mortgage is causing you hardship, you could qualify for a modification. Check your eligibility and then contact your lender.

Jumbo mortgage refinancing can be slightly more complicated, but the payoff is bigger too. A small improvement in your refinance rate equals greater dollar savings on larger loans.

Do You Need to Be a Homeowner?

You don’t have to be a homeowner to start a debt management plan. You just have to show that your current repayments are unaffordable, and that you are able to commit to regular reduced monthly payments.

The advantage of being a homeowner is that you may be able to add debt consolidation to your plan. By taking a home equity loan or doing a cash-out refinance, you could pay off the higher interest credit card debt and lower your payments considerably. Keep in mind that by stretching out your debt over 15 or 30 years you could end up paying more interest over the life of the loan. Still, debt consolidation by home equity loan or refinance can give you some breathing room, and you can always choose to make extra principal payments and lower your interest expense over the life of the mortgage.

Debt Management Education

An expert credit counselor is key–many so-called counselors are just salespeople who push everyone into the same plan. You want someone who provides some budgeting and credit education as well as debt management services. A reputable company should charge $100 or less, spend time evaluating your finanical situation with you, and discuss spending and lifestyle changes first. Streer clear of agencies that give you a hard sell and push a debt management program without offering alternatives. Keep in mind that non-profit status doesn’t mean that a service is any better or lower-priced. You need to evaluate it on its merits. The U.S. Dept. of Justice keeps a list of approved counselors on its Web site.

Debt Management: DIY

It’s possible to arrange a debt management plan yourself. You can negotiate interest rate freezes or reductions with your lenders directly, and if you have a good payment history with them and a documentable hardship, they are often willing to work things out. The process, however, may be time-consuming and stressful, and perhaps embarrassing. That’s why many prefer to have a debt management company deal with the negotiating, paperwork, and distribution of payments.

HAMP Help

HAMP is there to help homeowners with hardships avoid foreclosure. Qualifications include:

• House is your primary residence
• Mortgage is less than or equal to $729,750
• Mortgage taken out before January 1, 2009
• Total house payment exceeds 31% of household gross monthly income
• Hardship — a substantial loss of income or increase in expenses that’s not your fault AND
• Sufficient income to make a modified payment

If you qualify, contact your lender. Document your income, assets, debts, and hardship to get a trial modification and hopefully a permanent one. The average HAMP modification saves borrowers about $500 a month.

HARP Refinance

HARP is for borrowers who would be qualified to refinance except that they lack sufficient home equity. You can owe up to 125% of your home’s current value and still refinance under HARP. To qualify:

• Your mortgage must be owned or guaranteed by Fannie Mae or Freddie Mac
• You can’t have been more than 30 days late on your mortgage payment in the last twelve months
• Your first mortgage can’t exceed 125% of the value of your home

If you qualify, contact your loan servicer about a HARP refinance. You can get a HARP refinance from any Fannie Mae or Freddie Mac lender as long as your application is approved by Fannie’s Desktop Underwriter or Freddie’s Loan Prospector automated underwriting systems. If not, only your current lender can approve you under HARP. Another obstacle is mortgage insurance–with a new lender, you may not be able to obtain it.

Non-Government Help

If you don’t qualify for HAMP and don’t need HARP, a regular refinance may be your best bet–it allows you to shop for the best rate. An FHA refinance might be your best shot if you don’t have much equity.

Finally, if you’re having mortgage trouble but can’t get HAMP (say your house is a rental), call your lender. Homeowners get modifications when the lenders feel that they will lose less with modification than foreclosure.

Any time you refinance from one mortgage to another with the same term, for example thirty years, you extend the time it takes to pay off your home–and that could mean paying more over the long haul. So you need to look deeper than just the difference in your payment.

Refinancing: A Case of Imaginary Savings

Some lenders calculate your new payment, subtract your old payment, and proclaim that the difference between the two is “savings.” But that’s not the way amortization works. You can create fake “savings” by refinancing from one mortgage to a new home loan with the exact same interest rate! And you know that can’t possibly save you anything. Try this in your favorite mortgage calculator:

• Start with a $300,000 mortgage at 6% (your current loan). You have a payment of $1,799.
• Assume that you’ve been paying on it for ten years. If you look at an amortization schedule, you’ll see that your current balance is $251,057.
• If you do nothing, you would pay $347,514 in interest alone over the life of the mortgage.
• Now, here comes the refi: Put in a loan amount of $251,057 with a 30-year term, and don’t drop the interest rate.
• Your new payment is $1,505, which is $293 less. But of course you haven’t actually saved any money, your rate is the same.
• However, it will take you a total of 40 years to retire the mortgage and you will pay an extra $110,278 over the life of the loan!

What Affects Your Refinance Savings

If you haven’t had your current mortgage very long, the damage done by lengthening its term is minimal. Suppose you have only had your current mortgage for two years, and suppose you can get a 5% interest rate at a cost of $10,000. Using a mortgage payment calculator, refinance calculator, and amortization schedule, you see that after two years, your balance is still pretty high–$292,405. Your payment drops by $229, you recoup your closing costs in 3 years, 8 months, and over the life of your loan you save $29,073. So the three things that affect your refinance savings are:

• Amortization
• Interest rate
• Closing costs

Amortization is primarily the amount of time you’ve had your current mortgage and your remaining loan balance, the interest rate is the interest rate you’re offered by a new lender, and the closing costs determine how long it will take for the monthly interest saved to pay for your refinance.

Lower Monthly Payment Is a Valid Refinance Goal

Even if your overall interest expense in increased by a refinance, that doesn’t mean it’s a bad idea. If you use the extra cash to pay off high-interest debt, invest wisely, or take care of financial emergencies, cash today is a lot more useful than cash tomorrow. Just go into your refinance knowing what you wish to accomplish and what your trade-offs are.