Mortgage Rate Reset Shock: Not All That Bad?

The number of adjustable rate mortgages (ARMs) up for reset is set to peak this fall, with an estimated $50 billion poised to adjust to higher rates.

The housing market is bracing for another blow, but recent trends may mean the reset shock will be less painful than expected, CNN reports, especially if the Federal Reserve drops its key Fed Funds rate.

Ironically, the recent spike in home loan defaults on ARMs is one reason why borrowers with resetting ARMs should be better off.

Fixed-income mortgage investors are buying much safer investments, which has pushed up short-term bond prices and brought down interest rates.

“Many 2/28 hybrid ARM interest rates are based on 1 treasury yields,” said Allen Hardester, a mortgage consultant. “The new rate will be more affordable.”

From a recent high of 5.02 percent in mid-July, one-year Treasury yields have fallen to 4.09 percent as of September 10.

The reset rates of ARMs are calculated using an average of several treasury prices, but the final result should be around that 4.09 percent.

Add a margin of 2.75 percent (a common margin according to Keith Gumbinger of publisher of mortgage information, HSH Associates), and it totals an interest rate of 6.84 percent, compared with 7.77 before.

• On a $200,000 mortgage loan, borrowers will be paying $127 less at 6.84 percent than they would at 7.77 percent.
• For borderline borrowers, that could be the difference between being able to make home mortgage payments or not.
• Furthermore, many economists believe there’s a good chance the Federal Reserve will begin to lower the Fed Funds rate next week.

But Richard DeKaser, chief economist for National City Corp., warned that if the Fed lowers rates by only a quarter of a point, versus half a point, Treasury bill yields may not move much.

Not all resetting ARM borrowers will benefit from T-bill yield declines, either.

Many 2/28 hybrid ARM borrowers started their home loans at such low “teaser” levels that their mortgage rates will rise the contractual maximum of 3 percent even if yields do remain low.

And one large class of ARM borrowers - as many as half - who will not be seeing more affordable resets are those tied to LIBOR, or the London Interbank Offered Rate.

LIBOR has been moving in the opposite direction as treasuries. On September 5, the 30-day LIBOR was at 5.80 percent, up from 5.33 percent a month ago.

That would send the resetting LIBOR-based loans to about 8.45 percent, considerably higher than the ones tied to T-bill rates.

• But home loan resets based on T-bills will certainly be reasonable compared with historical averages if yields remain low or fall further.
• At 6.84 percent they’re not much higher than the rate for a 30-year fixed, which averaged 6.46 percent last week, according to Freddie Mac.

“It does take some of the pressure off,” said Gumbinger. “Maybe a borrower could now wait for a better deal [before mortgage refinancing].”

SOURCE: CNN Money