How To Know If Your Adjustable Rate Mortgage Will Adjust Lower

As LIBOR falls, ARM adjustments get less severe

When conforming mortgages adjust, they’re often tied to an interest rate index called LIBOR.

LIBOR is an acronym for London Interbank Offered Rate. But what LIBOR stands for isn’t as important as the role it plays.

LIBOR is an interest rate at which banks borrow money from each other.  Therefore, when banks feel the banking system as a whole is unsafe, LIBOR rises to compensate. 

It’s why LIBOR spiked last October after Lehman Brothers failed.  Financial institutions wondered what other institutions would fail and that added risk to the system.

Since October, however, and because of massive government interventions worldwide, LIBOR has been on a steady retreat.  Moreover, with close to $30 billion in conforming mortgages scheduled to adjust by Labor Day, the timing couldn’t be better for homeowners with conforming ARMs.

Typically, a Fannie Mae- or Freddie Mac-backed mortgage adjusts once annually.  The adjusted interest rate is always equal to some constant — usually 2.250 percent — plus the rate of LIBOR on the date of adjustment.

As a math formula, the ARM formula might like this:

New Mortgage Rate = LIBOR + 2.250 percent

In October, when LIBOR was above 4 percent, a homeowner’s ARM may have adjusted to 6 1/2 percent.  Today, that same ARM would move to four-and-a-quarter.

As a strategy play, it might make sense to let your ARM adjust because the rate will remain low, but with fixed rate mortgages hovering near 5 percent, locking up a long-term rate may be smart, too.

Give us a call to review all of your choices.