If your mortgage is set to adjust this year, the smart move may be to let it. Today’s conforming mortgages are adjusting lower than ever before — as low as 3 percent.  It may not be what you expected when you signed for your ARM several years ago.

The reason why ARMs are adjusting lower is because of how they’re made.

When conforming adjustable-rate mortgages adjust, they adjust according to a pre-determined formula. The formula is the sum of a constant and a variable.  The constant is usually 2.25 percent and the variable is a daily-changing interest rate called LIBOR.

The formula looks like this:

New Mortgage Rate = LIBOR + 2.250 percent

LIBOR is an acronym for London Interbank Offered Rate.  LIBOR is very similar to the Federal Reserve’s Federal Funds Rate.  Banks borrow and lend money from each other at the LIBOR or the Fed Funds Rate.

Normalcy is returning to banking and the timing couldn’t be better for Charlotte homeowners with ARMs. 15 months ago, a homeowner’s ARM may have adjusted to 6 1/2 percent.  Today, that same ARM falls to just above 3.

As a strategy play, it might make sense to let your ARM adjust. Or, because fixed rates are still near 5 percent, converting that ARM to a long-term fixed-rate product might make sense, too.  The decision is a balance between how low do you want your payment, and how long might you live in your home.

The longer you stay, the more it might make sense to switch to fixed-rate, even though ARM rates are so low.

If, however, you are in an Option Arm, and Interest Only ARM, or a Sub-Prime ARM, it won’t be so simple.  You want to carefully review the original mortgage paperwork to see what will happen with that loan when it adjusts. I can help with that.

If you’ve got a conforming, adjusting ARM, it makes sense to review why you chose that program 3,5, or 7 years ago – if htose reasons still amke sense, maybe you should keep it.  Of, it may be time to lock in a new rate for 5,7 or even 30 years.

WARNING: This a graphic story of the financial destruction of an otherwise financially successful man.

Here’s a secret for you – your credit score will go down every time you do something that people did previously just prior to defaulting on their debts.  The credit scoring model is trying to predict the likelihood of you going 90 days or more late on an account.  If someone ever defaults on a debt, they leave clues well in advance of that default.

Here is the pattern of clues John left as he trashed his credit following a medical incident that left him out of work for a few months:

1. John needed some cash, so he applied for new credit.
2. Having a lot of equity in his house, John applied for a home equity line, but the application was denied since he wasn’t working.
3. With the financial pressure of medical bills and no income, John could no longer pay off his cards in full each month.  The amount owed starts to increase close to the limit on the cards.
4. Needing cash, he turned to alternative sources, getting a signature loan at a high interest rate.
5. He was late on a few credit card payments as the money just wasn’t there to make the payments on time and he was juggling the many open accounts.
6. Creditors turned over John’s accounts to collection agencies, who immediately notified the credit bureaus of the collections.  Collection agencies wanted to lower his credit score to prevent him from opening new accounts, leaving him with a greater chance of paying the collection agency off.
7. (Trying to sell his house didn’t help as the market was slow and declining, so his equity was disappearing).
8. John first went to a credit counseling firm and then eventually filed for bankruptcy.
9. Some debts were wiped out in the bankruptcy, and he just quit making payments on the remaining debts, feeling the situation was hopeless.
10. Creditors file suit and judgments get reported to his credit report.
11. Being unable to manage then debt load, he is late paying his taxes and a tax lien is filed in court against him.
12. Unable to even make his mortgage payment with the high costs of his other bills, the house is lost in foreclosure and all the equity in the house disappears in the soft real estate market.

John’s credit destruction was now complete after just a few tragic months.  The impact will last for years, as most of these items will impact his score and stay on his credit report for seven to ten years.

While this story is a myth, the events and results happen to good people every day.

Following the StartwiththeHouse.com strategy would have helped:

1. Always have an emergency fund – this would have tied John over during the short period when he wasn’t working.
2. Keep credit cards and other loan payments very low
3. Have proper insurance against all the threats out there – not just uninsured motorists, but illness, sickness, death or lawsuits as well.
4. Store your cash where is can be accessed.  In the above story, John had over $200,000 of equity in his house – but with no job, he couldn’t access it and lost his house in addition to destroying his credit.

Your mortgage can’t be just a loan to be hated – today it has to be an integral part of your overall financial plan to help you succeed financially.  Could you survive two months without work with the increased expenses of a health issue?  If not, what are you doing to make sure you have a different outcome?

When you got a copy of your credit report (www.annualcreditreport.com) last week, I asked you to count your tradelines.  If you didn’t get your credit report yet, read this post first on how & why.  If you have been using credit for more than 10 years and have no late payments, you are at a place where you likely want to start using less credit.

The people I see with 800+ credit scores will have  a very good, long credit history, with never a late payment, collection account, or bad debt, and they will have very few active accounts.

• Pick 2 credit cards to keep open – usually Visa, MasterCard, or American Express, not department store or gasoline cards.  Pick the cards with the longest time open as well.

  

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Closing the other cards will not impact your score as you have a strong credit history.  If you have any blemishes on your report – skip this step!  It’s only to help someone go from really good credit score to outstanding, like  a 760 to an 800.

• Never miss a payment date.  In fact, I usually pay off both my cards in full every two weeks when I get paid to never let the balance get high.  You have to keep balances extremely low – like 10-20% of the maximum limit to have an 800 score.

• Stop new offers from coming in.  Visit www.Optoutprescreen.com to have your information blocked from credit card offers. This reduces the chances of fraud, identity theft, and new inquiries on your credit report.

Ideally, to get an 800 plus credit score you will have:

• Mortgage Loan
• 2nd Mortgage (Optional if needed)
• Auto Loan
• 2-3 Credit Cards that have been open for many year with very low balances

In my next post, I will show ways to get to a 740 FICO if you aren’t there yet.

I am offering a complimentary review of credit this month – if you want me to look over your report, email me for more information on this free, no obligation offer.

Know what you are working with!

If you haven’t seen your credit report in a while, get a copy now.  There is only one place for a truly ‘Free’ report – but it comes with a catch – www.AnnualCreditReport.com will give you a copy, but the catch is you have to pay for your score.  At this point, you don’t really need the score, but you can pay the extra money if you want to.

Other services (with catchy radio jingles) offer free reports, then try to sell you their service.  Use with caution.

When you get your report, you need to decide if you are in one of two camps:

1. I don’t have enough credit and need more credit history
2. I have very established credit history, and too much credit.

Your credit score will usually reflect the categories above – if you are below a 720-740 range, you need more or better credit history.  If you are above a 750, your score won’t improve further with more credit accounts, in fact, you probably have too many accounts to keep your score from getting even higher.

Credit scores range from 350-850

The lowest I’ve ever seen is in the 400’s, and I routinely see credit scores in the 800-810 range.  Above 820 is just luck.

What Score do you need?

• To buy a house with an FHA loan: 620 (Although the FHA says 580 officially)
• To buy a car:  700
• For a Jumbo Mortgage:  680-720
• Best rates on a Conforming mortgages: 740

Above a 740, credit scores are really just bragging rights, but the higher the score is, the more buffer you have in case something happens to your score. If you have an 810, for example, and a credit card payment gets lost in the mail, the late score won’t affect your home mortgage rate. However, if you have a 741, and then make a late payment, you will drop below 740, and then your mortgage rate would be higher.

Step One:

After getting a copy of your credit report – count the number of active “tradelines”, or active accounts that are on your report.

• More than 4 tradelines:  We’ll probably close some of them down.
• 4 or fewer tradelines: You will want to get some new credit.

Check back in a few days after you get your credit report copy and we’ll talk specific strategies for both groups.

I’ve decided that February is going to be Credit Score Improvement Month here at StartwiththeHouse.com and in Charlotte, NC. All this month, I am going to be posting tips and articles on specific things you can do to improve your credit score.

Why work on improving your credit score?

Your credit score impacts so many areas of your life.  My belief is that it is almost impossible to succeed financially today with a low credit score as the cost of bad credit is too much to overcome, short of winning the lottery.  Your credit score can impact:

• Mortgage rates
• Car loans
• Cell Phone plans
• Employment
• Medical Treatment
• Security Clearances
• Credit Cards
• Equity Lines

There are a lot of ‘Myth-conceptions’ about credit scores.  In fact, I still wince every time someone tells me “I am working on my credit score” as this usually means that what they are doing is exactly the opposite of what they should be doing to improve their score.

Several years ago, Sarah drove home this point.  Her idea of working on her credit, was to close all the accounts she no longer used.  Problem was, she didn’t use any credit cards, so she closed every account she had.  The end result was that her 728 credit score dropped to a 635 in less than a month.  Sarah was still able to buy a home, but the lowering of her score almost prevented that from happening.

Check back often this month, or subscribe to the RSS feed of this blog to learn more – I’ll be posting several articles this month with specific things you can do to raise your score starting this month.