Your Mortgage : Hidden Costs of ARM Conversion : Refinancing: Many homeowners who want to change to a fixed-rate mortgage find that it will be more expensive than they had thought.
When a young commercial artist bought a townhouse with an adjustable-rate mortgage three years ago, she was delighted with her selection of an ARM that could be converted to a fixed-rate loan. But as her date for possible conversion approaches, she is beginning to wonder whether it is such a great deal after all.
“There’s a lot of nerve-racking detail in this conversion process. All this makes me feel the bank knows a lot more than I do and that they’re counting on that,” she says.
Like many Americans who took out convertible ARMs a few years ago with the expectation of an easy conversion to a market-level fixed-rate loan, the artist is disappointed. Hours spent pouring over the fine print in her loan documents have convinced her that conversion will be neither easy nor necessarily economical.
“Conversion is a nice option, but many times people are surprised at the interest rate they have to pay,” says David Ginsburg, president of Loantech Inc., a nationwide mortgage advisory firm. “They realize they’ll have to pay a premium for the luxury of getting out of their adjustable-rate mortgage, that there’s no free lunch.”
Under typical mortgage contracts, the borrower must be willing to accept an interest rate three-quarters of a percentage point above the prevailing market rate to convert, according to Keith Gumbinger, president of HSH Associates, a financial publishing firm based in Butler, N.J.
That could result in a monthly payment more than $50 over market for a $100,000 loan or more than $100 for a $200,000 loan.
“People think that when they convert they can get that nifty low rate advertised in the newspaper, but that’s just not true,” Gumbinger says.
The popularity of convertible ARMs has been accountable to the fact that “Americans love to have their own way,” Gumbinger says. But what many home buyers failed to realize when they opted for a convertible ARM is that having your cake and eating it, too, comes at a cost, he says.
Many who took out convertible ARMs a few years ago mistakenly assumed they could simply convert to a fixed-rate loan bearing the same interest rate offered to the lender’s other customers at time of conversion, Gumbinger says.
What they didn’t notice, he says, is that the lender tacks a premium onto the market rate when a conversion occurs.
The premium is related to a figure known as the “margin.” In a conversion situation, the margin is the amount over and above some prevailing mortgage interest rate, or “index,” that the converting borrower must pay. Once the margin is added onto the index, many who convert wind up with higher monthly payments than they projected, mortgage experts say.
To make matters worse, grasping the arcane details of the conversion process can be difficult. Relatively obscure indexes are commonly used as the basis for pricing conversions, with the two most common related to wholesale mortgage rates set by two giant quasi-federal agencies that buy mortgages from the lenders who make them.
Information on the two Washington-area agencies, Fannie Mae and Freddie Mac, is not easily found.
Burrowing into the fine print of her loan documents, for instance, the artist learned that her new mortgage rate after conversion would be pegged to a Fannie Mae index. But the prose in her loan documents struck her as puzzling at best.
“If you exercise your conversion option, the new fixed interest rate will be equal to the Fannie Mae required net yield for 30-year, fixed-rate mortgages covered by applicable 60-day Mandatory Delivery Commitments in effect as of the date forty five (45) days before the conversion date, plus five-eighths of one percent (.625 percent) rounded to the next highest one-eighth of one percent (.125 percent),” reads the woman’s loan document.
Clerks at the savings bank that originated the artist’s mortgage are of little help in explaining such language or in providing information on where the Fannie Mae index stands now or has stood in the past, she says. “They act like Joe’s bank & grill,” she quips.
Still, mortgage experts say lenders are obligated to provide such information to borrowers with conversion options. Government agencies such as Fannie Mae and Freddie Mac are a back-up source for data on index behavior. And private consulting services, such as Loantech will, for a fee, verify that a borrower’s conversion has been correctly executed.
Gumbinger, the HSH Associates mortgage expert, says those with convertible ARMs shouldn’t necessarily assume that conversion is their best option, even though the up-front fee for a conversion usually runs only $100 to $500--a small amount compared to the cost of a full-blown mortgage refinancing.
He counsels homeowners contemplating conversion to weigh several factors when deciding how to proceed. These include the interest rate they’re currently paying on their ARM, where they think mortgage rates will go in the future, and how long they intend to remain in their home.
“If you’re only going to be there another year, it probably won’t pay you to convert your ARM,” Gumbinger says.
Of course, there are psychological as well as financial reasons to unload an ARM. Many a homeowner who took out an ARM a couple of years ago has been unnerved by upward adjustments on their mortgage rate and yearn for the certainty of a fixed-rate loan--even if that certainty comes at a price, mortgage experts observe.
Says the artist: “That’s what I bargained for when I took out a convertible loan and that’s what I really want.”
Los Angeles Times-Washington Post News Service.
AVERAGE RATES FOR RESIDENTIAL MORTGAGES
Average rates for residential mortgages as of Nov. 2, 1990.
Survey Conventional Mortgages Adjustable Mortgages Area 15 Year 30 Year Composite 1 Year Composite National 9.85% 10.18% 10.03% 8.10% 8.39% California 10.15 10.45 10.29 8.39 8.33 Connecticut 9.91 10.23 10.10 8.17 8.37 Wash. D.C. 9.69 10.08 9.91 7.77 8.13 Florida 9.85 10.18 10.03 8.03 8.25 Mass. 9.93 10.27 10.12 8.32 8.68 New Jersey 9.85 10.15 10.02 8.01 8.45 N.Y. Metro 9.93 10.24 10.10 8.15 8.49 New York 10.02 10.33 10.19 8.27 8.57 N.Y. Co-ops 10.24 10.55 10.41 8.53 8.88 Pa. 9.58 9.93 9.76 7.84 7.92 Texas 9.63 9.96 9.80 7.97 8.14
SOURCE: HSH Associates, Butler, N.J.
