My Personal Finance Journey

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5 Year Interest Only LIBOR ARM

Contributed by mm | March 22, 2004 2:40 PM PST

Early this month I had an interesting experience exploring my refinancing options. With the Treasury rate declining substantially from its level one months ago, I decided to try my luck in LendingTree. (Background: I got my current mortgage thru LendingTree last August.)

I went thru a long form to give out my personal information, current mortgage status and requirements. I specified that I was looking for a 5-year or 7-year ARM, but I was also receptive to other creative options.

The next morning, I received offers from four companies. Most of them quoted me 3.875% to 4.0% APR for 5/1 ARM and 4.125% to 4.375% APR for 7/1 ARM. However, one lender, Magellan Capital Mortgage, put an interesting deal: 5-Year Interest Only LIBOR ARM at 3.375% APR. It is just too good to be true that I started to wonder why a bank can afford to offer a lower rate for interest-only loan: it is apparently riskier than the common 5/1 ARMs.

To make sure this is the right deal for me, I wrote the following email to Magellan Capital Mortgage:

Thank you for responding to my loan inquiry at lendingtree. Your offer seems way low than other lenders. Can you confirm that based on my credit, you will be able to give a 5/1 LIBOR ARM with fixed rate of 3.375% in the first five years? Is this an ARM or balloon? If possible, can you give me a Good Faith Estimate based on the information you have? Please also let me know if there are any prepayment penalty and hidden fees.

My enthusiam was quickly discouraged with the reply:

"The 5/1 Interest Only LIBOR ARM is not fixed for 5 years, it can adjust every 6 months depending on what the LIBOR index does. The 5/25 Balloon I quoted you is similar to an ARM but at the end of the 5 years you have the option of converting it to a fixed rate loan for the remaining 25 years of the loan. We also have a standard 5/1 ARM at 4.125%.

"Our company does not require you to pay a lock fee and there are no other fees associated with the estimates that I am sending you. We have a $975 processing and underwriting fee that we charge if we process your loan but that can be rolled into the loan amount so you would not be required to pay anything out of pocket."

Gosh! Should you communicate clearly in your offer that this is a 5/6 ARM instead of a 5/1 ARM? If you only say "5 Year Interest Only LIBOR ARM," shall people assume it is a 5/1 ARM, which is much more commonplace than 5/6 ARM?

Of course I rejected the 5/6 offer. With the current fixed income market climate, it is just too risky.

Once again, if something is too good to be true, it probably is not true.

This Post Has Received 2 Comments. Share Your Opinions Too.


Hiren Commented on November 22, 2004

Hi,

Read you site once a week. Excellent Job. I see you decided to go with a ARM mortgage. I am currently deciding between a ARM and a FRM. However, I am leaning towards a FRM since we are in the increasing rate environment mode and generally everybody agrees the ARM rates in 3-5 years being higher than they are currently. I know you have a great rate for you ARM, however, are you not concerned that the rate might skyrocket in 3-5 years and increase your Debt to Income ratio? I am sure you have gone through those calculations. Just wanted to get your insight on that.

Thanks,
Hiren


mm Commented on November 22, 2004

Hi Hiren, thank you for your comment. In my case, I did run some detailed calculation before making the ARM decision; my calculation shows no matter how fast rate increases, I would be better off with ARM for the first 7 years. My house is a start-home in my area so my wife and I believe we will move before 7 years. How long you expect to live in your next home is the most important factor in the ARM vs FRM decision, and it really depends on each one's stage of life. I cannot say for sure ARM or FRM is best for you.

Hope this helps,
MM


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