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For most folks, dawdling on ARM refi is bad news

While the media and the market scrutinized every word of the Federal Reserve Board's message last month, it seemed to overlook the most important signal, which was there loud and clear for anyone reading between the lines.

It went like this: "Refinance your adjustable rate mortgage now, if you can."

That's the logical interpretation of the Fed's position; if the days of a falling interest rate environment are over and the only logical direction over the next 12 to 18 months is up, then anyone looking at a mortgage reset is in line to take a beating.

Worse yet, with the real estate bubble still deflating, home prices are shrinking, which will make it tougher for many homeowners to get the job done.

The Stupid Investment of the Week typically focuses on specific securities or purchases an investor can make. But this month, in honor of Independence Day and the homeownership component of the American dream, it looks at hanging on to those ARMs now that the rate environment is working against you.

Stupid Investment of the Week highlights the concerns and conditions that make an investment less than ideal for the average consumer. In this case, plenty of homeowners should have made their move away from an ARM a year or two ago. At this point, however, when it's obvious that rates have only one direction to go, waiting is almost certain to produce pain.

Homeowners who used ARMs to buy their homes -- about $2.2 trillion-plus in variable loans were issued from 2004-06 -- have thus far managed to dodge the reset bullet, thanks to the Fed's rate-cutting actions which turned a wave of forecast refinancing issues into a nonevent in 2007 and thus far in '08. About $370 billion in ARMs reset in 2007 and $250 billion-plus will be going through the process this year and next, according to First American, a real estate data firm. An additional $700 billion in ARMs will reset in 2010.

Most people don't think about mortgage resets until they get close. By law, lenders must give consumers 25 business days' notice of what rate changes, if any, are scheduled to take place. Typically, notice is sent about 45 business days ahead of a change, but some loans call for three months' notice.

According to BankRate.com, the national average for a 30-year fixed-rate mortgage stands at 6.15 percent. While rates tend to move a bit in a narrow band, so that someone might be able to catch a slight break, the view is different when you back the lens out to see the long-term trends. At that point, it becomes clear that rates stay fairly steady over long stretches, but have short periods of tremendous volatility.

In other words, miss this train as it leaves the station and you'll pay dearly.

"Your last rate reset may have been a nonevent, but your next one won't be," said Greg McBride, senior financial analyst for BankRate.com. "Start looking now, and be ready to go, because you might win the battle and be able to get a rate that is marginally better than what's out there today, but the way that housing prices are falling -- and that homeowners are losing equity in their home as a result -- you might lose the war and not be able to get that better deal because you can't afford it any more."

Cameron Findlay, chief economist for Lending Tree, says that homeowners facing a reset need to analyze the numbers and their circumstances.

There will be times when they may be able to ride out a reset, or where their situation makes their current deal better than what they can get on the market. With home prices falling, some homeowners will find it's too late to get a new deal; they no longer qualify and will have to stay put in their variable deal.

"If you are planning to move in the next two or three years, it may not make sense to jump into a refi right now," Findlay said. "The Fed's not going to be able to increase rates in a rapid manner, so you don't have to rush out and get a deal, but you do need to be prepared because the only direction rates are going to go from here is up."

The key for homeowners is that thin line between being able to prolong the good rate they have on the ARM and the point where, because of falling home prices, they may not be able to qualify for a better fixed-rate deal and are facing a 1 percent or 2 percent pop in the interest rate on their current deal.

Typically, homeowners facing their first reset can expect a rate and payment hike, with any subsequent changes to follow the market. The initial issue is the payback for getting a discounted teaser rate; the first reset is when the lender gets to make up for that sweet deal. If rates have fallen since the loan was originated, the drop would have to be greater than the initial discount to prevent rates and payments from going up.

"It's a pretty safe bet that if you are able to refinance out of your ARM into a longer-term fixed rate, now is a great time to look and probably a pretty good time to get it done," said Gerri Detweiler, author of "The Ultimate Credit Handbook."

"Your payment is most likely going up either way, with a reset or a new mortgage, so don't avoid a new loan because it feels more expensive," Detweiler said. " Just go get the best deal while you can right now, because while no one knows when these deals are going away, we know that conditions are not getting better from here for a long time."

Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you've got a comment -- or a suggestion for SIOTW -- you can reach him at cjaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.

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