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How the rate is figured in adjustable rate mortgages



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September 12, 2007
Alex,

I have an Adjustable mortgage where the rate went from 8.2 to 11.2 in February. Now I received a letter saying the rate is going to 11.625 this October. In that same letter the index rate that determines my interest rate has gone from 5.4 to 5.25. How can the index rate go down yet my rate go up?

— A.D., Imlay City

A.D., Almost all adjustable rate mortgages are tied directly to the LIBOR rate which stands for London Inter Bank Offered Rate. This is the rate that banks charge other banks when they borrow money. This is often called the index. The way most adjustable loan rates are figured is by taking the LIBOR rate and adding a particular margin rate to it. This margin varies widely on individual mortgages. It could be 3% for one person and 6% for another. For example on your loan your rate is figured by adding the LIBOR rate plus their margin of 6.375%. It says this in your loan documents that you signed when you refinanced. All adjustable mortgages are also limited by how much they can rise in any one period. Yours is a mortgage that can readjust every six months and can rise by as much as 3 interest points every time. So what happened in February was the LIBOR rate was 5.4 and when you added the margin of 6.375 you would have had a rate of 11.75%. However, since your rate cannot increase by more than 3.0% in any given period your mortgage company was limited to increasing your rate to only 11.2% which is 3% higher than the 8.2% you were paying. Now the next period is coming due and even though the LIBOR rate dropped when you added it to the margin your rate increased slightly. This is why your rate has gone up while the index or LIBOR rate went down. You never should have refinanced into an adjustable rate in 2005, especially at a rate of 8.2%. Fixed rates were less than 7% back then. Your best bet now is to refinance if you can. However, since values have dropped I doubt you could since you probably owe more than your home is worth. I would recommend immediately contacting your lender and request that they modify your note to a fixed rate mortgage of 8.2%. Tell them that you cannot make the higher payment amount based on 11.625% and that they would be better served to lower your rate than to have to take back your home which is no longer worth what you owe them. It may take some work on your part to get them to agree to this but many banks are now doing this because they know that taking back your home in a foreclosure will result in them losing much more money than if they were to just renegotiate your interest rate. The sticker shock of higher mortgage payments that you are experiencing right now is why I always recommend fixed rate mortgages. Nothing ever changes in a 30 year fixed mortgage! These adjustable rate mortgages are the primary reason we are seeing so many foreclosures these days. I also recommend calling your Realtor before anyone ever refinances their mortgage. Lenders are not bound by any code of ethics like Realtors are. Your Realtor will give you good professional advice on what type of mortgage and the associated costs would be best for you. This advice is free and can save you the headache that A.D. is experiencing right now.

Alex Lengemann is a licensed Real Estate Broker who operates RealtyVolution.com, a local real estate company. You can Ask Alex your real estate or mortgage questions by phone 810-664-1819 or by email Alex@RealtyVolution.com.

— ADV

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Van Dyke Gas
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