Refinance mortgage?

Question: Yes, I'm one of those people with a sub-prime mortgage. When I got divorced and took over my mortgage, money was tight, so I got a 5 year ARM at 4.625. The lower rate expires in April of next year, and goes to LIBOR plus my margin of 2.25. Right now, that would mean a rate of about 5.5%, which would mean my monthly payment would go up about $100.00, which I'm not crazy about, but I could manage. My mortgage is about 40% of my take-home pay. However, who knows what the LIBOR is going to do, and my rate continues to adjust each year on the anniversary. If I refinanced right now to a fixed rate, I think I could get something like 6.6%, which would raise my current payment about $175 dollars, plus I would have to start over at 30 years.

Here's the kicker: my mortgage is held by WASHINGTON MUTUAL! Am I exposing myself to anything dangerous by not going with a different lender? What should I do? When should I do it? I feel paralyzed with indecision. Victoria, Los Angeles, CA

Answer: Ouch! From the subprime to WaMu, the largest bank failure in U.S. history. You've had quite a window into the making of recent financial history. On a more serious note, you may feel paralyzed with indecision, but you've already started the process of calculating how much your monthly mortgage payments would go up if you kept your adjustable rate mortgage at current rates. You're right to be wary of what rates will be in the future. You've also figured out what a fixed rate will cost you. That's a good start. To jump to my bottom line, I would refinance at a fixed rate at the new WaMu/Chase--or another bank. But it won't easy.

Now, for some elaboration on why I say that. Regulators seized and sold most of WaMu to J.P. Morgan Chase & Co. The transaction went remarkably well. The mismanaged Seattle thrift was going under as depositors withdrew money at an accelerating pace. (As an aside, the one agency that has performed admirably throughout the financial crisis has been the FDIC. Indeed, if Washington had listened earlier to Sheila Blair, head of the FDIC, and her prescient persistent calls for a comprehensive mortgage solution we wouldn't be in the current financial catastrophe contemplating a $700 billion bailout. The FDIC is no FEMA and Blair of the FDIC is no Brown, the incompetent former head of FEMA during hurricane Katrina.) WaMu customers were getting money from ATMs this morning.

You're now a customer of the JP Morgan Chase, the largest bank in the U.S. measured by deposits. There's no rush to refinance right now, not with the bailout negotiations continuing in Washington D.C. But I would go to your branch and talk to a loan officer. I would have him or her look at your mortgage and see what options will be available to you and at what cost. You should also check out what competing institutions will offer you, since the takeover gives them an opportunity to nab some new customers that want to say goodbye to Wamu--even in its latest incarnation--for the last time. Hopefully, Chase will want to keep you as a customer (they did spend several billion buying WaMu's customers, after all). So see what kind of fixed rate refinancing mortgage is available to you after taking into account your credit score, the value of your home, and market conditions.

What's more, to break the paralysis I would play a financial version of Pascal's wager. Pascal is famous for saying, "Is there a God, or is there not a God?" Of course, there is no real answer to the question. But Pascal argued that we can rationally decide to act as if there is a God or act as if there isn't.

Peter Bernstein, the dean of finance economists, has long argued that people should think through a financial version of Pascal's wager. First, he says, we can't piece the investment fog of the future. There's no certainty--it's in the nature of the beast. Instead, he recommends focusing on how serious will be the financial consequences if it turns out that your wrong in your bet? If the bet goes wrong, how bad could it be and how much will it matter to your finances.

You could gamble that LIBOR will stay low. And if it does, you'll be just fine. But what if LIBOR soars, how much will it impact your finances? My own feeling is that with 40% of your income already going toward housing the downside risk is big. I would focus on getting into a fixed rate mortgage. And its fine if it is with your current lender.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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