Adjustable Rate Mortgages

When you get a loan to buy a house, you can choose a fixed-rate or an adjustable-rate mortgage. A fixed rate means the interest rate stays the same for the life of the loan. An adjustable-rate mortgage (ARM) has a variable rate.

Most ARMs provide lower interest rates at the beginning of the loan, and then the rate varies depending on the index it is tied to. If you’re buying a house that you’re sure you will only be in for a few years, you can usually save a significant amount of money with an adjustable-rate mortgage.

Some ARMs have fixed rates for the first year (or even the first several years), but eventually the rate changes. The amount of the change depends on the index and the margin of the loan. Lenders often use the U.S. Prime Rate as their base lending rate, then add a margin based primarily on the amount of risk associated with a loan. Other common indices include the 10-year Treasury bill, the cost of funds index (COFI), and the London Interbank Offered Rate (LIBOR). Margin is a specified rate above the index, usually 1 to 3 percent. This margin gives the bank the incentive to lend money to you or me and not just buy treasury bills at the index rate.

Before you sign on the dotted line, be sure you understand which index your adjustable interest rate is tied to and what the margin is. Some indices are more volatile than others.

Try to avoid the temptation of low interest rates associated with an ARM if you don’t plan to move in the next few years. While telling themselves, “I’ll probably move,” people sign up for the ARM and then get stuck with higher interest rates than they would have if they had started with the fixed-rate loan.

This is especially true when the ARM begins with an introductory rate that’s a teaser rate—a rate that isn’t fully indexed. Let’s say your loan is tied to the LIBOR at 2 percent with a margin of 2 percent. That would make the fully indexed rate 4 percent. An introductory rate less than 4 percent is a teaser rate, and people fall for teaser rates all the time.

If you qualify for the ARM based on a teaser rate, but you will not be able to afford the mortgage when the rate becomes fully indexed, this is not a good plan. However, if the initial interest rate allows you to qualify for the loan and you know your financial circumstances are about to improve (your spouse is returning to work once Junior goes to kindergarten next year, for example), then it’s fine.

The best way to figure out which type of loan is right for you is to work with your Realtor and a local lender. Be up front about your financial resources and your plans as they relate to your income. Lenders have many loan programs to choose from, so the more information you provide, the better they can help you find a loan that best meets your needs.

If you have questions about real estate or property management, please contact me at or call (707) 462-4000. If you’d like to read previous articles, visit my blog at Dick Selzer is a real estate broker who has been in the business for more than 40 years.


Interest Rates and the New Dodd-Frank and Federal Consumer Finance Protection Bureau Regulations

Most people in real estate don’t expect interest rates to stay down much longer. As unemployment drops and the economic recovery gains momentum and therefore demand for business borrowing, the pressure to raise interest rates increases. In addition the federal government has spent $17,000,000,000,000 more than they had. They therefore borrowed the money. This results in a requirement to pay it back. It will be paid back with increased taxes or with inflation. I don’t think they have political will to do it with taxes and that leaves inflation. With inflation comes higher interest rates.

A one percent increase in interest rates results in about a 12.5 percent increase in your monthly mortgage payment. Let’s say you have a $100,000 loan and the rates go from four percent to five percent. Your monthly payment will increase from $477 to $536 per month. This happens because each payment is made up of principle and interest. The vast majority of most mortgage payments are made up of interest in the early years, and they equal out over the life of the loan. If your payment were all interest and no principle, your monthly payment would increase by 25 percent.

As of January 10, 2014 home loans will be more difficult to get. The new Dodd-Frank and Federal Consumer Finance Protection Bureau regulations go into effect, requiring lenders to become far more restrictive. The biggest change will be in the debt-to-income ratio. Currently, you can borrow up to about 50 percent of your gross income, but that will drop to about 43 percent in 2014.

If you make $60,000 a year and pay $500 a month for your car payment and $100 a month toward your credit card debt, right now you’d qualify for a mortgage of about $285,000. However, when the new regulations take effect in January, you’ll only qualify for about $215,000 (if you qualify at all). In addition, there are new requirements to prove you make the $60,000 per year. If you’d like more details (and by more I mean MORE) about the new regulations, go to

Depending on whether this significantly impacts the number and size of loans, the increased cost of dealing with the regulations will be passed on to consumers. In other words, with fewer loans of smaller sizes and increased regulations the cost of getting a loan will go up.

The bottom line is this: if you are thinking of buying or refinancing, sooner is better than later. Financing never justifies making a bad real estate or bad investment decision, but if the decision is already made, consider the current state of financing and act before the end of the year.

For the past couple weeks, I’ve encouraged people to consider donating to the Ukiah Valley Christmas Effort ( Many wonderful local charities care for local people during the holidays and year-round. Tax-deductible donations make good financial sense, and more importantly, help us strengthen our community. The Greater Ukiah Chamber of Commerce has a list of non-profit members listed at If you have more time than money, you can always volunteer to help out.

Next time I’ll write about investing in real estate. If there’s something you would like me to write about or if you have questions about real estate or property management, feel free to contact me at or visit our website at If you’d like to read previous articles, visit my blog at Dick Selzer is a real estate broker who has been in the business for more than 35 years.

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