The interest rate against which adjustable-rate mortgages change is falling — evidence that the global banking system is starting to stabilize.
On any adjustable-rate mortgage, the initial “starter rate” remains fixed for some period of time, and then adjusts according to some pre-determined rules.
For a conforming mortgage, an ARM will typically adjust once per year, based on this formula:
(Adjusted Rate) = (Variable) + (Constant)
Where the variable is often assigned to 12-month LIBOR, and the constant is often fixed at 2.250 percent.
LIBOR is the equation’s variable. Therefore, it’s of paramount import to holders of ARMs. LIBOR is the rate at which banks lend money to each other. The 12-month LIBOR, therefore, is the borrowing rate for a 1-year, interbank loan.
So, to take the formula and apply to an real live mortgage, a homeowner’s adjusted mortgage rate would be equal to whatever the 12-month LIBOR is at the time of adjustment, plus another 2.250 percent.
Looking at the chart, note LIBOR spiked in September. It’s a direct correlation to the September 15 failure of Lehman Brothers. That bank shutdown started a wave of “who’s going to be next?” anxiety on Wall Street but as global governments stepped up support for banks, LIBOR predictably fell.
For homeowners with adjusting mortgages, this is terrific news.
However, mortgage markets have rallied a bit this week, created an interesting opportunity for some holders of ARMs. Depending on credit scores and the amount of home equity, mortgage rates on a new loan may be lower that the soon-to-be-adjusted mortgage rate of the old one.
In other words, getting a new loan may be smarter than letting your current mortgage change. Contact your mortgage lender to see which plan fits you best.