Automatic Rate Cut Refinancing

Imagine being able to secure an interest rate that can only go down and never up. Too good to be true? Let’s just say that the Automatic Rate Cut (ARC) mortgage is going to be very popular in home refinancing.

As you probably already have guessed, this statement must be qualified. Also known as an automatic rate reduction loan (ARR), most large lenders have not yet begun to offer ARCs.

ARC/ARRs have been around since the turn of the century, but they still are not talked about much. What makes them even more appealing are the offers from lenders to pay all closing costs associated with the ARC/ARR. So why isn’t this the most popular mortgage in the country?

There are three main reasons:

1. With an abundance of loan products on the market, people are attached to the mortgage terms with which they are familiar. For example, adjustable rate mortgages have been around only since the late 1970s in response to uncertain economics of the era, so they just recently gained popularity.
2. Many lenders are reluctant to offer a key consumer-oriented bonus of ARC/ARRs: no closing costs.
3. This is the kicker: ARC/ARRs almost always start out above the current market rate.

Though an ARC may be of interest to many people, there will be a period of test marketing until lenders really are ready to advertise this new product. Until then, ARC/ARRs are reserved largely for certain types of borrowers:

• Individuals with excellent credit.
• Individuals with no late payments in the 12 months prior to a request for an ARC adjustment.

This does not mean, however, that consumers with less than perfect credit cannot get some advantage from an ARC/ARR. We will discuss that in just a minute…

If you are eligible for one of the better ARC/ARR loans, you can expect the following: a three-year adjustment period with a -0.50 (first year), then a -0.75 (second year), and finally a 1% (third year). This adds up to a rate cut of -2.25%.

If you have credit problems, it definitely is worthwhile to consider an ARC/ARR. ARC loans are advantageous for riskier (so-called ‘sub-prime’) borrowers. Instead of higher interest rates, these loans allow borrowing below sub-prime rates, and both rewards and stabilizes borrowers’ ability to pay a mortgage.

Anyone confident in his or her ability to “bet” on interest rates also could do very well with an ARC/ARR. Banks may help you to play this game: After approval for an ARC/ARR, the borrower must wait 120 days to see if interest rates drop. So what happens if the rates drop before 120 days, but are back up on the 121st day? Most banks will give you the lower rate, but make sure to ask about the bank’s policy before you apply.

Lenders likely will start providing ARC/ARRs to reward their best customers. While not dealing with a typical ARC/ARR, many lenders already employ similar strategies. For example, Fannie Mae has the Timely Payment Loan program that provides borrowers with lowered interest rates after 24 consecutive on time payments.

Many lenders initially dismissed ARC/ARRs when they first were introduced, but now they seem to boast much staying power. You can expect to hear more about this intriguing loan option in the near future.