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Fred W. Holland

Your Upcoming Interest Rate Adjustment


During the period from 2005 through 2007, one of the more popular mortgages was a “hybrid” loan which combined a 3, 5 or 7 year fixed rate with a 6 month or 1 year adjustable rate for the remaining term equaling 30 years.  At the time of origination, many borrowers felt they would have the opportunity to refinance prior to the adjustable rate becoming active, so they would not have to worry about the volatility of the shorter term adjustments.  As our market has changed and values have decreased, this option is not as readily available.  As a result and if the fixed portion of your mortgage is coming to an end, you may be wondering what will happen next.  Following is a short explanation of what takes place when this adjustment occurs.  As you can imagine there are a number of particular circumstances that come into place, all of which can have an impact on the actual adjustment to your mortgage payment.  Please bear with me because I will have to work with certain generalities.  I would be happy to speak with you regarding your particular circumstance. 

There are 2 types of adjustable (variable) rate products.  These determine how often your upcoming rate can adjust.  The 1 year adjustable rate, has a maximum rate increase (or decrease) of 2% per year and is generally capped at 5% over the original rate for the entire life of the loan.  The 6 month adjustable rate has a maximum rate increase (or decrease) of 1% every 6 months (2% per year) and is generally capped at 5% over the original rate for the entire life of the loan. In certain cases, there can also be a larger one time increase immediately following the fixed rate portion as well as a higher cap.  The new interest rate will be mainly determined by one of two indexes. The London Inter Bank Offering Rate (LIBOR) is an average of the interest rate on dollar-denominated deposits, also known as Eurodollars, traded between banks in London. The Eurodollar market is a major component of the International financial market. London is the center of the Euro market in terms of volume. The LIBOR is an international index which follows the world economic condition. It allows international investors to match their cost of lending to their cost of funds.  The daily highs and lows of the index become the average for that particular day.  The Treasury Bill (T-Bill) is also known as the Constant Maturity Treasury (CMT).  The CMT isn’t a single security or note.  It is the weekly or monthly average of the interest rates of all the treasury debt that is maturing in the coming 12 months.  They are based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market.  They reflect the state of the economy and respond quickly to economic changes.  The daily highs and lows of the index become the average for that particular day.  

To determine your upcoming interest rate, the lender will look at the specific index 45 days before each adjustment.  On that date, they will take the average of the variable index for the prior 12 months and add a fixed percentage (this is called a “margin” and is another word for bank profit) to the index to determine the new rate.  This margin will generally be between 2.25% and 2.875%.  The new loan would also be based on a shorteramortization as you have used a portion of the initial 30 years (either 3, 5 or 7 years).  

There are many websites which will tell you the 12 month average of your index or you can simply call or email me. You can find the specific type of index, the margin and how often the adjustment will occur with your original paperwork.  It will usually be clearly stated in the “Adjustable Rate Rider” as a part of the “Note.” 

Let’s take an example.  First we will need to make certain assumptions.  For our example, the following will apply…   

  • The current loan originally closed on 6/20/04. 
  • The loan amount was $200,000.00.  The current balance is $185,000.00.
  • It was fixed for 5 years, following with a 6 month adjustable rate.
  • The index for the adjustment is the LIBOR (see explanation).
  • The margin is 2.50% (see explanation).
  • The original interest rate was 5.25%. 

 In this scenario, you began paying full monthly interest to the lender on 7/1/04 (1st payment date was 8/1/04).  Your current rate should change on 7/1/09.  The lender would check the 12 month average of the LIBOR index in mid May, 2009 and contact you shortly thereafter. 

Currently, LIBOR is an excellent index and has remained extremely low.  The high for the period 7/1/08-6/30/09 was 3.981% and the low was 1.240%.  The average for the entire 12 months was 2.397%Adding the 2.50% margin to the average index, your interest rate would actually lower to 4.897% for the next 6 months.  However, your payment will actually increase by $34.00 due to the shortened amortization (25 years).  This is process for the adjustment every 6 months. To be clear, your payment can increase or decrease depending upon the “then” value of the index, the margin and the remaining amortization of the loan.   

Needless to say, there is no way to know what the index will be at the time of your adjustment and this is where the question of volatility enters into the equation.  The other obvious option would be to look into a refinance of your current mortgage.  With this option, there would be no worry about what the market may or may not do.  I would be glad to discuss this with you as well as help you determine the potential new interest rate if you decide to stay with your current loan.  Once we take all of the factors into account, we can figure out what the best option might be for you.  I would be glad to do this at your convenience, though I suggest we do this as soon as possible while interest rates are near historic lows and prior to your pending adjustment.   

I know this is a lot of information, so please feel free to email or call me and I'd be glad to answer any questions.  I look forward to hearing from you.   
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