If rates are low, why am I paying so much?

interest rate house  I received this question from Maria today:

Q: I have an adjustable mortgage and my current interest rate is 9.375%. Why would this not decrease considering we are at a low national average?

A: That is a good question Maria, and one a lot of people have. There are two reasons why your rate could be 9.375% when today’s fixed rate is only 3.5%.

First, it depends on what your margin is. If you have a high margin, you’ll have a high interest rate, no matter how low rates go. I’ll explain.

An adjustable rate mortgage has a margin as well as the index it is based on. Let’s say your loan is based on the index called LIBOR (London Inter-Bank Offered Rate), the most common index used for adjustable rate mortgages. Today, the LIBOR rate is 0.48%.  Your margin is added to that rate to determine what your interest rate is. If your margin is 9%, then your rate would be 9.48%. WOW, that is a high rate!
And it’s pretty close to what you are paying.

You can see the importance of paying attention to what your margin is when you take out an adjustable rate mortgage (ARM).

The second reason why your rate is so high could be the floor. Every adjustable rate has a start rate and a floor. The start rate is the interest rate you start out at. The floor is the bottom your interest rate is allowed to go.

A lot of subprime ARMs were written with the start rate the same as the floor.  If your start rate was 9.375% and the floor is the same as the start rate, your interest rate can never go below 9.375%, no matter what. OUCH, that hurts a lot when rates go down!

You can see the importance of also paying attention to what the floor is on an ARM.

Unfortunately, a lot of smooth-talking loan sharks sold ARMS with bad terms, which earned them high commissions. The higher the margin was on an ARM, the higher commission the loan officer earned. In Mortgage Rip-Offs and Money Savers, I tell a story about a loan officer who made $40,000 commission on one ARM that had a high margin and a prepayment penalty. And by the way, if you haven’t read this book yet, go check out the reader feedback and pick up a copy. It’s a real eye-opener.

The Truth-in-Lending form shows you all the terms of your ARM, including: start rate, index, margin, floor, and cap (the maximum interest rate). Back in the subprime heyday, a lot of loan officers never bothered to send customers–or should I say victims?–the TIL. Or, they sent the TIL, but it was left blank. A proper TIL for an adjustable loan is supposed to show you a worse case scenario of how your loan can change.

By the time borrowers got to the signing table and finally got to see a proper Truth-in-Lending for the first time, they glossed over it and signed away without paying any attention. Of course, it didn’t help that some of these signers distracted people with jokes and gossip and other conversation while they were signing.

Get out your TIL from the stack of papers you signed. Look at the figures for the margin and floor. That will tell you why you’re paying almost 5% higher than today’s rate. Also look to see if there is a prepayment penalty; and if so, when it expires. If you don’t have a prepay penalty in place now, you definitely want to look into refinancing.

Folks, before you or someone you care about signs for a mortgage, take a couple days to read Mortgage Rip-Offs and Money Savers. It could save you thousands, if not tens of thousands, of dollars as well as a lot of stress and grief.