There was an insightful story over at the Washington Post recently on the vulnerable position that borrowers who have adjustable rate mortgages (ARM’s) are in right now. Rates on ARM mortgages have been extremely low recently as the Fed has kept interest rates low to stave off the recession. But sooner or later the Fed will begin to raise rates and when they do ARM rates (along with fixed rates) on mortgages will start shooting up. For many borrowers who plan to own their homes for years to come it would be wise to lock in a 30 year fixed rate now while rates remain low. Here are some bits from that story:
The stakes are high. The borrower with the 2.6 percent ARM who was paying 4 percent initially probably has a maximum rate of about 10 percent and a rate adjustment cap of 2 percent. That means that if the one-year Treasury rate jumped overnight to 10 percent and stayed there, the ARM rate would adjust to 4.6 percent at the next adjustment, 6.6 percent one year later, 8.6 percent the year after that, and it would top out at 10 percent one year later. Since the fixed rate would escalate with the Treasury rate, the opportunity for a profitable refinance would be lost.
Of course, rates never jump 10 percent overnight. The process occurs over a period of time, which can tempt ARM borrowers to wait until the rate increases start before making a move. But that is easier said than done because the market can move very fast.
In January 1977, for example, the one-year Treasury rate was 5.29 percent. One year later, it hit 7.28 percent; one year after that, it was 10.41 percent, and in March 1980, it reached 15.82 percent. That was an unusual episode, but these are unusual times. Indeed, the rise in rates this time could be even faster.