Unless you have a long term fixed rate mortgage, you should develop an exit strategy. An exit strategy is a well thought plan on how you’re [photopress:airplaneexit.jpg,thumb,alignright]going to leave your current mortgage. Every time you board an airplane, the Stewardess reviews the “exit strategy”. They’re not planning on an actual emergency landing, they are simply preparing you for a worse case scenario and informing you where the exits are and what you need to do in that event.
You should have a plan if your current mortgage is:
- Any type of adjustable rate mortgage (ARMs)
- Option ARMs (negative amortization a.k.a. deferred interest)
- Any balloon mortgages (recently common with subprime mortgages such as 2/28 or 3/36)
Having a plan (being prepared) does not mean waiting until you receive a notice from your mortgage company that your mortgage payment is hiking because your fixed period on your ARM is over. You need an exit strategy because once fixed period is over and your mortgage adjusts, odds are that your new mortgage payment will not be desirable or affordable.
You need to start developing your plan well in advance. Here’s what I recommend:
- Find the Note for your mortgage (deed of trust) and determine what your new rate may be using the worse case scenario. If you have an ARM, you can figure this out by adding the first cap to your interest rate. For example, if you currently have a 5/1 ARM with a note rate of 5% and the first adjustment rate cap is 5% (5/2/5 is a common cap structure), your new rate could be 10%. If the first adjustment cap is 2% (2/2/6 is another possibility); your new rate could be 7%. If your ARM has an interest only feature and will also be converting to amortized payments (some have longer interest only terms beyond the fixed rate period), you’re in for a double whammo if you’re keeping the mortgage.
- Determine what your worse case payment may be. Your new payment will be amortized over the remaining term of the mortgage. Use an amortization schedule to see what your mortgage balance will be at 60 months (using the 5/1 ARM scenario) and figure your payment based on the maximum possible rate amortized for 300 months. This new payment does not include taxes and insurance. In fact, anyone with an adjustable rate mortgage, regardless how long the remaining fixed term is, should contact their LO to determine what their “worse case payment