Opinions and insights from real estate broker Rick Bosl

If your adjustable rate mortgage is due to adjust this year, don’t go rushing to replace it just yet. Your soon-to-adjust mortgage rate may actually go lower. It’s related to the math behind the ARM.

Conventional, adjustable-rate mortgages share a common life cycle:

1. There’s a “starter period” in which the interest rate remains fixed
2. There’s an initial adjustment period after the starter period called the “first adjustment”
3. There’s a subsequent annual adjustment until the loan’s term expires — usually at Year 30.

The starter period will vary from 1 to 10 years, but at the point of first adjustment, conventional ARMs become the same. A homeowner’s new, adjusted mortgage rate is determined by the sum of some constant, and a variable. The constant is most often 2.25% and the variable is most often the 12-month LIBOR.

As a formula, the math looks like this:

(Adjusted Mortgage Rates) = (12-Month LIBOR) + (2.250 Percent)

LIBOR is an acronym standing for London Interbank Offered Rate. It’s the rate at which banks borrow money from each other and, lately, LIBOR has been low. As a result, adjusting mortgage rates have been low, too.

Last year, 5-year ARMs were adjusting to 6 percent or higher. Today, they’re adjusting to 3.375%.

Based on the math, it may be wise to just let your ARM adjust this year. Or, depending on how long you plan to stay in your home, consider a refinance to a new ARM.  Starter rates on today’s adjustable rate mortgages are exceptionally low , as are the rates for fixed rate loans.

Either way, talk to your loan officer about making a plan. With mortgage rates as low as they’ve ever been in history, homeowners have some interesting options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.

When conforming mortgages adjust, they’re often tied to an interest rate index called LIBOR. Many people incorrectly assume ARMs will always adjust upwards, but that is not always the case.

LIBOR is an acronym for London Interbank Offered Rate. But what LIBOR stands for isn’t as important as the role it plays.

LIBOR is an interest rate at which banks borrow money from each other.  Therefore, when banks feel the banking system as a whole is unsafe, LIBOR rises to compensate. 

It’s why LIBOR spiked last October after Lehman Brothers failed.  Financial institutions wondered what other institutions would fail and that added risk to the system.

Since October, however, and because of massive government interventions worldwide, LIBOR has been on a steady retreat.  Moreover, with close to $30 billion in conforming mortgages scheduled to adjust by Labor Day, the timing couldn’t be better for homeowners with conforming ARMs.

Typically, a Fannie Mae- or Freddie Mac-backed mortgage adjusts once annually.  The adjusted interest rate is always equal to some constant — usually 2.250 percent — plus the rate of LIBOR on the date of adjustment.

As a math formula, the ARM formula might like this:

New Mortgage Rate = LIBOR + 2.250 percent

In October, when LIBOR was above 4 percent, a homeowner’s ARM may have adjusted to 6 1/2 percent.  Today, that same ARM would move to four-and-a-quarter.

As a strategy play, it might make sense to let your ARM adjust because the rate will remain low, but with fixed rate mortgages hovering near 5 percent, locking up a long-term rate may be smart, too.