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Like Saving Money? Consider an ARM When You Refinance

By Gina Pogol
Mortgage Credit Problems Columnist


Many bad credit mortgages are adjustable rate mortgages (ARMs), and they start out with a reasonable interest rate, then skyrocket when the introductory period is over. These adjustments were the cause of many sub-prime defaults, according to First American CoreLogic, which tracks mortgage statistics.

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Bad Credit Refinancing: Some ARMs Are Stronger than Others

However, don't judge all ARMs by the performance of sub-prime or bad credit mortgages. Prime and FHA ARMs at market interest rates have dropped to less than 4%. And unlike bad credit adjustable mortgages, which often adjusted to 11% or higher, FHA ARMs have reasonable caps on increases, limiting one-year or three-year ARM adjustments to just 1% per year and no more than 5% over the life of the loan. Five, seven, and ten-year ARMs can adjust a maximum of 2% per year and 6% over the life of the loan.

Adjustable Rate Mortgage Refinance: How You Save Money

If you are like most people, you are not going to keep your current home and its mortgage for the next thirty years. In fact, the average time homeowners keep their homes is about seven years--and only about three if it's your first home. According to the U.S. Census Bureau, one in six Americans moves in a given year. So look at your future plans when considering a mortgage refinance.

For a home purchase or mortgage refinance, FHA offers a standard 1-year ARM and four hybrid ARM mortgage products. Hybrid ARMs feature an initial interest rate that is fixed for the first 3, 5, 7, or 10 years. After the introductory period, the interest rate adjusts annually. With rates on 5-1 hydrid ARMs a full point lower than 30-year fixed rate mortgages, you could save a lot over five years. For example, on a $300,000 mortgage, you'd pay $72,014 in interest during the first five years at 5%, and only $57,278 interest on a 5/1 ARM at 4%. That's a savings of $14,736! What if you keep the home longer? Well, the highest your rate can go in year six is 6%.

Mortgage Refinance to ARM: What to Look For

An ARM has four components:

  • Index (a published financial indicator)
  • Margin
  • Interest rate caps
  • Introductory interest rate period

At the end of the introductory interest rate period, the new interest rate is calculated by adding a margin to the index. The margin is set by the lender and can be negotiated (margins vary from lender to lender, so it's is a good idea to shop around. You can do this by completing the online form on this site). As the index moves with financial markets, your FHA interest rate is adjusted accordingly, once a year. Index options on FHA-insured ARM loan transactions are the Constant Maturity Treasury (CMT) index and the 1-year London Interbank Offered Rate (LIBOR). Increases or decreases in the interest rate are limited by the interest rate cap as explained above.

So, unless your plans for your home are permanent, consider refinancing your bad credit mortgage to an FHA ARM. Then make plans for the money you save.

Sources

http://www.firstam.com/ / http://www.hud.gov/offices/hsg/sfh/ins/203armt.cfm / http://www.census.gov/

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