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Will our adjustable rate mortgage save us big money?

Almost five years ago, we financed our first home purchase with a 5/1 ARM interest-only mortgage. If you’re not familiar with mortgage lingo, it breaks down into the following, at least in our case:

  • 5/1 ARM (Adjustable Rate Mortgage) means that for the first 5 years, our mortgage has a fixed rate. For us, that’s 5.25%. But after the five years, the interest rate changes to a prime plus margin.
  • Interest-only means that we’re only paying the interest due on the mortgage, but none of the principal (unless we choose to send extra with our payment).

Hearing this and knowing the mess with strange mortgages and falling house values, you would think we’re pretty scared when this rate resets. In fact, the rate will reset in November!

A few more details of our loan:

  • The interest-only portion is actually for the first 10 years, not the first five. That means we won’t have the added cost of principal tacked on for another 5 years.
  • Our prime rate is based on the 6-month LIBOR (a British rate).
  • Our margin is 2.25%, rounded to the nearest .125%
  • The first rate change min/max is 2.25%/11.25%, and each subsequent change is capped at 2% up or down. The rate can only go up to 11.25% for the life of the loan.

Ok, with all that out of the way, what does this all mean?

We’re going to save BIG $$

The bank picks the rate on the first business day of the month PRIOR to the month it is set to change. That means our first rate is picked on October 1, 2009, and will go into effect in November.

I’ve been on pins and needles watching the 6-month LIBOR, but now that we’re so close to October, I know we’re going to make out like bandits. The market could have made the rate skyrocket, but instead, the rate has plummeted over the last year. You can see the current 6-month LIBOR for yourself.

As of this post, it’s hovering around 0.70%.

If you actually read what I wrote up above, you’ll do the math:

.7 (prime) + 2.25 (margin) = 2.95% => 3.00% (rounded)

Our rate is dropping from 5.25% to about 3.00%

I can’t foresee anything happening to make the prime rate jump, and even so it would have to jump from 0.7% to 3.0% to equal our current rate (3+2.25=5.25).

What’s this mean in terms of $$?

Our current payment (just interest) is about $1400.

Our new payment should be $800

We’ll be saving $600 dollars per month in interest! And that’s going to be for at least 6 months until the rate changes again. When it does, it won’t go higher than 5%, so we’ll still be saving money.

What will we do with the extra money?

While we could be throwing the extra money at new cars, new TVs, or just sticking it in the bank, we chose something else.

We’re just going to keep paying the same amount each month as before. We’re well aware that rates will not stay this low forever, so we need to continue to build up equity and savings in order to refinance our mortgage eventually.

Would you do the same?

About the author

Clever Dude

4 Comments

  • @MJ, what I didn’t mention here is that we have 2 mortgages (it was covered in the linked post, or a post linked to that post). We’re paying down our second mortgage first since it’s a higher rate. Now we’ll be paying down principal on both.

  • I’m 4 years into our 7/1 ARM. I’ve considered refinancing with historic lows, but I just can’t justify it right now. Our rate is 4.25% with 3 years left. Plus, we’re still above $416k conforming loan at $425k, down from $460k when we started. Thus if we wait it out, even if rates are higher in a couple years we could be under the jumbo rates, in which case rates drop.

    Plus with $2k closing costs, the rates have to be fantastic.

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