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Adjustable Rate Mortgages have been very popular over the last few years. When interest rates are going down, they are very favorable. The most popular of these programs have been the 3/1 and 5/1 ARMs with interest-only payments.

Alan Greenspan has warned homeowners who used hybrid loan programs, which allowed for no downpayment and interest-only payment options, to purchase their homes may be in trouble with interest rates on the rise. A recent Washington Post article by Nell Henderson, overviewed Greenspan’s acknowledegment of the impact Hurricanes Katrina and Rita will have not only on the U.S. economy but on the economy world-wide. In addition, Henderson’s article references Greenspan’s comments to Japanese executives in Tokyo, which agree with predictions that higher energy costs will force consumers and businesses to cut spending.

Once consumers and businesses begin to cut spending, the economy slows. Companies may be forced into freezing wages or laying off employees. If the Fed continues to push interest rates up and inflation increases, consumer budgets will be further strained. Even with conservative estimates, those with an adjustable mortgage could be facing up to a 30% increase in their monthly payments as rates continue to rise.

Salary increases have been fairly flat in recent years. Businesses facing rising costs usually reduce spending, therefore, salaries are not likely to increase. If you’re facing the potential of an adjustment in your interest rate in the next 2-3 years, refinancing into a fixed rate now may save you from having an over-extended budget later.

For homeowners who commute 30 minutes or more to work one-way, gasoline prices have already put a dent in their discretionary income. As the costs other goods and services continues to increase due to higher fuel costs, budgets will tighten even further.

There is no one-size-fits-all solution to these problems but proper planning now can prevent agonizing over your bills later.

Things to consider:

1. If you have an ARM, is it already adjusting or is your fixed period going to expire within the next 2-3 years? If so, talk to a qualified mortgage professional or other financial advisor about the potential benefits of refinancing into a fixed rate now.

2. Do you have a significant amount of unsecured debt? If so, begin paying that debt down. The less unsecured debt you have the better off your long-term financial picture will be.

3. Do you have a pool of emergency funds that can cover all your expenses for several months if you have an unexpected loss of income? Pay yourself first, even if you are trying to reduce your credit card debt, make sure you are putting some money away each month for emergencies and retirement.

4. Are you expecting to fund your child’s college education? Re-consider this plan. You may be better off investigating other ways for your child to get a college education and saving for your retirement instead. There are numerous scholarship, grant and financial aid programs that can allow your child to get his/her education without you bearing the financial burden. Work-study programs also provide students with the ability to gain real work experience while paying for their education.

5. Do you have an equity line of credit? If the rate on your equity line is increasing rapidly, you may want to consider refinancing into a fixed rate 2nd mortgage or refinancing your 1st and 2nd into one loan with a fixed rate. A mortgage professional or other financial advisor can help you determine if the aggregate APR will make such a move cost effective.

6. Do you have a financial plan, goals? If you do, great, review them. If you don’t, begin establishing your goals and the plan necessary for you to meet them. Be realistic, but plan positively. Look at things like your income, debt, net worth, savings plan, retirement plan, investment strategies and seek the help of a qualified professional if you’re uncertain what to do.

7. Evaluate your current budget and spending habits. Where can you make changes that will have a positive impact on your bottom line? Knowing what, where and how you spend you money can mean the difference between financial security and financial disaster.

8. Save for what you want! Before credit was so readily available, people who wished to buy a new living room set, go on a special vacation, or purchase a new car, saved up for it. By budgeting and planning ahead, you can prevent over-extending yourself and creating unnecessary debt.

In a meeting earlier today, an associate agreed that anyone with an adjustable rate mortgage should consider refinancing into a fixed rate. As the discussion progressed, I realized my associate had an interest-only ARM himself. Since the ARM had a “fixed” rate period, he wasn’t considering his own mortgage when he made the comment about refinancing.

This mindset could be a problem for many borrowers who, because of their “fixed” period, haven’t considered that they need to refinance yet. The risk—-by the time the “fixed” period expires, the rate adjustment may be so high that the payments are no longer affordable.

While there is no way to predict exactly what rates will do over the next several years, it’s a fair guess that they probably won’t be as low as they have been in recent history.

What does this mean to the average homeowner with an ARM?

Every ARM has caps and margins which are added to the index rate when the rate is going to adjust. If your caps are 5/2/5, that means on the first adjustment period, the rate can increase up to 5%, the annual increase thereafter is a maximum of 2%, and the maximum over the life of the loan is 5%. The new rate will be determined by adding your margin to the current index rate. So if your margin is 2.25 and the current index is 6, then you add 2.25 to 6 to get your new adjusted rate of 8.25. The caps are there to ensure that your rate can’t go above the maximum increase allowed for the loan program.

What does this mean in terms of monthly payments?

Let’s say, if you locked your 3/1 Libor ARM at 5.5 a year ago and the caps are 5/2/5 with a margin of 2.25, that means 2 years from now if the libor, currently at 4.35, is 6.35 the new interest rate will be 8.6 percent. If you’ve made interest-only payments on your $300,000 loan, you still owe $300,000. Therefore, your interest-only monthly payment which was $1375 is now $2150. That’s a $775 per month increase which would significantly impact most individuals’ budgets.

If the same loan were refinanced now into a 30-year fixed rate of 6%, the principal and interest (P & I) payment would only be $1798.65, an increase of only $423.65. Even adding escrow in most cases would keep the payment below the $2150 of the earlier scenario. And, on top of the fact that your principal and interest payments will never increase, you also have the benefit of making monthly payments toward the principal instead paying only the interest. This ensures you build equity even if the real estate market cools considerably and property isn’t appreciating very much.

So the question is can you afford to wait? While you must also consider the cost of refinancing into a new mortgage, it may still be more cost effective than risking a significantly higher payment down the road.

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Associated Press reported Freddie Mac’s recent annoucement that 30 year mortgage rates have risen to their highest level since March. Currently at 5.98, which is up .7 percent from last week, according to nationwide averages.

Rising interest rates are the result of the Fed’s strategy to keep inflation under control. As natural disasters have severely impacted our ecconomy in recent weeks, the Fed’s strategy may not provide the expected relief. Additionally, higher rates and increased fuel costs are further eroding the discretionary income of consumers. Many are tempted to limit or put off saving due to more immediate financial pressures.

Now, more than ever, it’s time for individuals to take the long view and save for their future. While Americans commonly plan for shorter-term expenses such as college funds for their children, they routinely fail to plan appropriately for their long-term financial needs.

For further insight, read Matt Branaugh’s, article “Save for Retirement First, then for College” on www.delawareonline.com.

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With the change in interest rates over the last few months, re-evaluation of your adjustable rate mortgage is a good idea. A client who purchased a home last year with a pay option, interest-only ARM recently asked me to do just that for him.

At the time of his purchase, he had not sold his home in Northern Virginia but needed to go ahead and close on the new home in Richmond. The program we chose for him was great at the time because the lender didn’t take issue with the new purchase being made prior to the current home being sold. The lender also didn’t object to the equity line loan that we used to bridge funds for down payment and closing costs. The pay option allowed my client to keep his payments affordably low while he was making mortgage payments on both houses.

Now, a little over a year later, the former home has been sold, the index on the ARM went up and his payments have been continuing to adjust upward too. (Note: Many pay option ARMS are based on indices that adjust monthly.) The increase in payment from his initial one has been over $350 per month. That is an uncomfortable increase for most homeowner’s budgets. Looking at the situation now, circumstances being very different, the pay option ARM just didn’t make sense anymore. While there was the expense of refinancing in the form of closing costs, we roled those costs into the new loan amount so that he wasn’t out-of-pocket any monies at the closing table.

Through the evaluation, even though the loan for the refinance would be higher to cover closing costs, converting to a fixed rate saved him the $350 a month increase and he no longer has to worry about his payments adjusting. With the increase of fuel costs, that $350 savings is a big plus and more than offset the expense of the refinance.

Situations like these are common. The best way to ensure that your mortgage is right for you now is to have your mortgage professional help you evaluate it based on current conditions. If the mortgage you got only two or three years ago no longer works for you as market conditions change, then it’s better to address it now than to wait until the situation worsens further.

Protect your home investment and your fiscal health. Regularly reviewing your mortgage should be part of that process just as you regularly review your other investment choices. A qualified mortgage professional can help you determine what solutions are available and which one is going to ensure that you continue to meet your long-term financial goals.

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Many homeowners, who purchased homes in the last 2 to 4 years while interest rates have been on the downward swing, ARMed themselves. Now those ARMs are looking a little financially dangerous.

When the trend is downward for interest rates, a good mortgage choice is a short-term ARM (adjustable rate mortgage). For some of these homeowners, especially those with pay option ARMs, monthly payments were even more affordable and they were able to purchase homes in a higher price range than they could have under different market conditions. With soaring appreciation, new homeowners haven’t been concerned with building equity in their properties by reducing the loan principal.

The flip side now is rates are going up and those previously low payments are going up too. With the onslaught of hurricanes to our Gulf coast and the resulting shortages in gasoline and natural gas, other costs are increasing as well. With the approaching winter months comes the question of whether or not those ARM mortgage payments will continue to be affordable. Increased costs for fuel, goods and services means that previously comfortable budgets are going to be strained.

Any homeowner finding their monthly payments increasing and/or concerned about higher rates when their ARM fixed period expires should be considering refinancing their mortgage now, while 30 year fixed rates are still below 6%.

If mortgage rates continue upward and basic expenses continue to increase, homeowners that have stretched themselves are going to find meeting their monthly obligations much more difficult. Refinancing now can ensure that your payments remain within your budget. In addition, if a homeowner has equity in their property, refinancing provides the opportunity to tap the equity to pay off other unsecured debt or to hold funds in a liquid investment account which allows easy access in case of a financial emergency such as a loss of income.

Are you ARMed?

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Economic growth is largely dependent on consumer spending. With gas prices over $3 a gallon and $100 billion in losses from the devastation of the hurricane-ridden Gulf coast, consumer spending dropped by 1 percent in August, the biggest decline since the fall of 2001.

Additionally, the personal saving rate of Americans in August was a negative at 0.7 percent. While that was higher than July’ s all-time low of negative 1.1 percent, it’s not an improvement when you consider that it means Americans are spending all their after-tax income and then some. Many are dipping into monies that had previously been ear-marked for college tuition, retirement, and/or emergency funds. Now that money is being used to cover the increased costs of commuting and goods. Unfortunately, it’s only the beginning.

Some of the economic reports read as if Americans are dipping into their savings just because they are spend-happy. The truth is, for those that have savings, increased costs of gas, goods and healthcare coupled with a fairly stagnant wages, tapping those funds provides the only alternative for meeting daily needs.

For those who have no savings to tap, the increased cost of gas and day-to-day necessities, like food and medicine, have had to utilize additional credit. Those with no credit are fairing the worse. While the Fed worries about inflation, the average citizen is worried about how to pay the ever-increasing bills. A recession is appearing on the horizon.

Americans need realistic solutions to these financial burdens. Increased short-term interest rates are compounding the problems of the already strapped consumer, but even if rates were dropped, giving consumers the ability to further deepen their credit card debt won’t help on a long-term basis.

Whether or not we are facing a major recession, it will be necessary for all Americans to make some major adjustments in their everyday activities. The rising cost-of-living over the coming winter months will put an additional burden on the already strained budgets of most. Finding ways to reduce and/or eliminate unnecessary expenses, becoming more economical in day-to-day activities and conserving financial resources is the only way that we can survive successfully.

Consider your habits, your activities, your debt, your income and your savings. Think about what you really need versus what you want. As a society, we are often portrayed as being to addicted to the acquisition of “stuff” and that’s true to a large degree. As time goes on, it will increasingly necessary for each individual to evaluate what’s really needed. Taking any steps necessary to protect your financial security is the best defense in uncertain, volatile economic conditions.