Now May Be Time to Switch to Fixed-Rate Mortgage

Rates hit fresh lows.

Fixed mortgages have now seen their lowest yield level of the year thanks to the ongoing turmoil on Wall Street. This development provides another attractive opportunity for home owners with adjustable rate mortgages to refinance before their introductory rate heads higher.

Many borrowers with an ARM loan are not familiar with the calculation method which will be utilized by their servicing lender when the discounted "teaser" rate expires. While there are many ARM types, the arithmetic is usually very similar.

Each ARM loan has an "index." This may be a widely published intermediate rate such as the five-year Treasury note, a synthetic rate based upon a one-year constant maturity index or a short-term yield such as the various flavors of the LIBOR or COFI indices.

Let's say the index value is currently 5 percent. The second element involved in the calculation of the new ARM rate is called the "margin." This is often in the area of 2.75 percent but it may be higher or lower.

When you add the index to the margin, the result is the new rate. In the above example, the adjusted payment calculated utilizing the remaining term of the loan would be 7.75 percent.

However, that rate may be above the one permitted by an adjustment cap. If the initial rate was 4 percent with a maximum adjustment of 3 percent, your new rate would be held to only 7 percent. That resulting figure is about 1 percent higher than the current 30-year fixed rate.

The other wild card in the ARM calculation is the current outstanding balance of your loan. If you had an ARM with a very low initial payment, there's a chance you received a loan with negative amortization potential.

In other words, if you borrowed $100,000 and your payment was artificially reduced, you may now owe $110,000. In that situation, your new payment after the first adjustment will be based upon the larger loan amount, thereby setting your new monthly payment substantially higher than would have been the case if the loan amount had been lower after a year or more of regular payments.

All the information about how your loan adjusts and how frequently it changes is in the paperwork you received at closing.

The key document you want to pull out of that package is the promissory note. It will be several pages long and will include a description of the index utilized to calculate your adjustable rate as well as specify the margin on the loan. It will also describe the adjustment cap and the life-of-loan cap if they are present.

The other element to research is whether there is a prepayment penalty on your loan. This may not be stipulated on the promissory note but may appear as an addendum to the note.

The prepayment penalty must be declared on another document known as the final Truth In Lending disclosure which is required by federal law. This is the item with the boxes across the top which include the annual percentage rate, the finance charge and the estimated total outlay. Further down on the page is the statement about whether a prepayment penalty is applicable to your loan.

If you wish to refinance, take the closing paperwork from your current loan to the office of your local mortgage professional or make an appointment for an in-home visit and have the documents handy for review. The loan originator will go through the information to verify your current circumstances and will also ask to see any recent paperwork you may have received from your current lender.

The key to any conventional refinance is to be current on your existing mortgage payments. If you act now, you may be able to extricate yourself from the ARM loan and benefit from the simplicity and predictability of a fixed-rate mortgage. But the window of opportunity may not remain open for long. Act now. A new loan may be the best holiday present you receive.

As we move into the new week, here are what some key indicators are telling us. A plus (+) sign means the category is on the side of lower interest rates, a minus (-) sign means the forecast is for higher rates, and a zero (0) means the item is giving a neutral reading.

David Beadle is a mortgage industry analyst. The opinions expressed here are those of the author. They should not be seen as representing the views of Reuters or