Costco Connection - July 2007

Getting a leg up on

troublesome ARMs

PLENTY OF HOMEOWNERS are dealing with major mortgage stress this year. An estimated $1.5 trillion in adjustable-rate mortgages (ARMs) is scheduled for a “rate reset.” That’s when lenders get to adjust the interest rate based on current market conditions.

KEI TH LATHROP

Unfortunately, those conditions boil down to higher rates. That’s because the Federal Reserve has spent the past few years raising the federal funds rate, and ARM interest rates follow the lead of the fed funds rate. For example, in 2004 you could have snagged an ARM with a fixed rate for the first three years of around 4. 5 percent. But now it’s time for the first adjustment, and that 4. 5 percent is going to jump to at least 6 percent.

On a $200,000 mortgage, that means an increase from a $1,013 monthly payment to $1,200. Borrowers who took out mortgages with lower initial rates are facing even more painful adjustments this year.

My advice is to do your best to absorb the pain. I think it can make more sense to pare your spending habits than to consider refinancing into a different mortgage.

I understand the allure of refinancing into a fixed-rate mortgage to protect yourself from future rate shock. But, depending on your situation, that could be a costly move. Refinancing usually costs you money— typically 3 percent or more of the loan amount.

Don’t be fooled by a lender who purports to offer you no-fee refinancing. There’s always a fee: When it isn’t an upfront cost, it’s simply hidden in a way that isn’t so obvious, such as a slightly higher interest rate. So you have to weigh the cost of refinancing against what you gain.

■ If your ARM reset is close to the going market rate of about 6 percent for a 30-year fixed rate, don’t

That’s where it gets even more interesting. If you have an ARM that is adjusting, odds are the new rate will be in the vicinity of 6 percent. That’s about what you will get with a 30-year fixed rate. So refinancing into a fixed rate won’t necessarily save you in terms of a lower monthly bill.

The big caveat is, what about 12 months down the line when your ARM is up for its next annual adjustment? If rates rise, your payment will jump again. But I think that over the next year or so the greater likelihood is for rates to stay where they are or even decrease slightly.

In other words, I think the risk of future rate shock isn’t so high if you stick with your ARM. What to do? Here’s a strategy.

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rush to refinance. You probably can solve your problem with spending cuts.

Start with your monthly bills. Trim the cable to standard, cut out the land line and rely on your cell phone—that alone can save you $75 or more per month. I bet scaling back on eating out can easily save another $50 to $75 per month.

If you need to save more, ask your insurance agent about raising the deductibles on your home and car insurance to at least $1,000. That should drop your premium by 10 percent or more.

You get the idea: Look at each expenditure and ask yourself, “How can I reduce this cost?” A bit of conscious trimming can unearth a couple of hundred dollars in extra cash each month.

■ If you have an ARM that is resetting at a rate at least 1 or 2 percentage points above 6 percent, and you have a FICO credit score of at least 720, consider refinancing only if you intend to stay in the house for a few years. While you may be able to lower your monthly payments, you want to make sure that the savings are enough to recoup your refinanc-

ing costs. Ask your lender to calculate how long it will take for your monthly savings to offset the refinancing cost.

■ If, after the budget trimming, you still can’t afford to cover your new reset payment, consider selling. I know that’s a drastic move—but so is ruining your financial life by falling into delinquency and foreclosure on your home. There is no shame in downsizing, moving to another neighborhood or even renting for a while. It takes strength to take the responsible route. C

“A bit of conscious

trimming can

unearth a couple

of hundred

dollars in extra
cash each month.”

Suze Orman’s latest book is Women & Money: Owning the Power to Control Your Destiny. Suze’s TV show airs Saturday nights on CNBC. She can be contacted at www.suzeorman.com.