July 27, 2008
Adjustable Interest Rate May Go Down
July 27, 2008
Dear Dave: We took out a 3 year A.R.M. just over 3 years ago. It was indexed at 2.25% above the LIBOR rate (whatever that is) and was originally 4.25%. Last year, on our 3 year anniversary, the rate went to 6.25% and is set to renew again in November of this year. We don’t want to go to 8.25% and are asking if we should switch to a fixed rate? In fact, our lender is offering that alternative.
Answer: If you have an adjustable rate, don’t ever jump to the conclusion that it will go up. You will receive many marketing pamphlets in the mail urging you to switch to a fixed rate but this should alert you to the fact that someone is trying to make money from your ignorance.
If your A.R.M. (Adjustable Rate Mortgage) was adjusting in August 2008, for example, your rate would probably adjust down, not up at all, to approximately 5.5% because the index would calculate that way. In fact, many adjustable rate mortgages could well adjust downwards if they reset between now and the end of the year. Here’s why - - -
An ‘A.R.M.’ has a start rate, an index, a margin and a cap. Your particular rate was set at 4.25% for 3 years and this probably seemed very attractive in 2004. On the 3 year anniversary, in November 2007, it was set for its first adjustment.
Your adjustment was based on the LIBOR rate – this is your index. The “London Inter Bank Offered Rate” is only one of several indices used for ARM’s. You can track the LIBOR rate online (just Google it). To be more specific, your index could have been the 3 month, 6 month or 1 year LIBOR rate, but usually is the 1 year (Check your Note).
In November 2007 the 1 year LIBOR rate was around 5% (changes daily). Your ‘margin’ was 2.25% - that is, your rate will be calculated each year as the LIBOR rate plus 2.25. However, it is apparent that you have a ‘Cap’ of 2% maximum increase in any given year. That is, whilst your rate could have adjusted in November 2007 to Libor + 2.25 (i.e. 5 + 2.25 = 7.25%), your 2% Cap prevented that occurring because your previous rate was 4.25%. So, 4.25 + 2 = 6.25%, which was the cap. The index calculated 7.25% but your rate increase was capped at 6.25%. Hooray for you!
However, this year could be better. You need to watch the LIBOR rate closely. Normally, the new index calculation is made 30 to 45 days ahead of your actual anniversary. See your Note for specifics, but let’s assume your anniversary is 1st November 2008 and the Note states your index calculation will be based on the LIBOR rate 30 days ahead as published in the Wall Street Journal.
On the 1st October you should check the LIBOR rate and add your 2.25 margin. In any event, the Cap would prevent your lender from exceeding your current rate + 2 (i.e. 6.25 + 2 = 8.25%). This would be the maximum you could pay for the next year.
However, I predict LIBOR will stay under 4% for you. Even if LIBOR is a full 4% on October 1st 2008, your new rate would stay exactly where it is now (4% + your 2.25% margin). More likely, your new rate and new monthly payment will actually come down!
For those of you without the mathematical skills to follow this argument, simply remember this – Adjustable Rates can go up or down and, this year, could well go down depending on your Index, your Margin, your Cap and your Existing Rate. Ask lots of questions before signing any new deal that promises you the world.
Hi Dave: I am in the process of purchasing raw land for investment purposes (possible recreational cabin in the future). The purchase will be a cash transaction and no realtors will be involved. When I spoke to a title company, the title officer mentioned that a title search does not necessarily avoid all possible liens on the property. To avoid possible future liens (from the seller) on the property, purchasing title insurance is recommended. I thought a title search is to make sure that the buyer is indeed the owner of the deed and to check for any liens on the property. Can you clear this up for me please? Also, what is the average cost of title insurance? Thank you for any clarification you can provide.
Answer: I thank you for your question because it reveals several misunderstandings about Title Insurance which many people share, not just you.
Title insurance is designed to provide a fundamental sense of security to anyone purchasing real estate. While not mandatory in your privately arranged transaction, a buyer would be foolish not to demand it. The expense, which is indexed to the value of your transaction, is normally paid by the seller. A minimum rate of $250 will be charged but it would cost $582 for a $100,000 transaction, $882 for a $200,000 deal, or $382 for a $50,000 transaction.
If you order Title insurance you incur the $250 basic fee immediately, and this must be paid whether you close or not. This covers the cost of the title search. The title search will reveal all “recorded” liens against the property, but not unrecorded liens. That is, there may be some money owed somewhere, secured by the property, but never publicly recorded.
Your Title insurance does not protect you against unrecorded liens (they are difficult to enforce anyway) or from many other items (e.g. a faulty As-built survey), but it does provide ‘reasonable’ certainty of clear title being transferred to the buyer.
After closing, you will receive a policy stating that you are, indeed, the new title owner. In your question you also refer to ‘future’ liens from the seller. There can be no such thing because liens cannot attach in the future to the property you buy unless they are your liens, not liens of someone else.
Title insurance is not a title guarantee. It is a policy of insurance issued by a company, after reasonable research, to cover your ownership of the property. If something comes up which the Title Company should have discovered, they will pay to make it go away. However, you should clarify all the exceptions to the policy, just as with any other kind of insurance.
