Question: I have a single mortgage with a balance of $212,000 on a 30-year fixed rate of 5.875 percent. The house is worth at least $275,000. I have good credit, good income and a reasonable savings account. I like where I live and am not planning on moving.

I have been offered a six-month LIBOR loan that changes to a 15-year loan after the first 10 years. The rate is four percent with no origination fees but maybe some points up front. He wants me to pay a few points but I am hesitating. He tells me I would be saving $330 per month right away. If I pay extra towards principal every month, he says my balance will be very low in 10 years.

I then saw a recent column you wrote about the one-month LIBOR. He didn't mention this to me. Here are my questions: Would this type of program be a good move for someone in my financial position? If so, should I look for a one-month LIBOR instead of a six-month LIBOR? Many thanks for your time.

Answer: First I'll answer your questions. Based on what you have told me, I would not recommend that you refinance to either a one-month or six-month LIBOR loan. I'm a big fan of LIBOR based loans for certain people, but they can be complicated so it's very important that a borrower understands the program. The scenario that you have outlined leads me to believe that your loan officer hasn't fully explained the program. You need to ask several very important questions.

LIBOR stands for London Interbank Offering Rate. Basically, this is a rate that European banks charge each other for borrowing short-term funds. When we talk about a LIBOR-based mortgage, we are talking about an adjustable rate that will move along with its LIBOR index. For example, the one-month LIBOR rate is currently at about 1.60 percent. A typical margin for a monthly LIBOR mortgage might be two percent. Adding the 1.60 percent and the two percent will make a "fully adjusted" mortgage rate of 3.60 percent.

Similarly, the six-month LIBOR rate is currently at about 1.95 percent. Adding the same margin of two percent will result in a six-month LIBOR mortgage rate of 3.95 percent.

As these LIBOR rates move, the LIBOR mortgage rates will also move. A mortgage tied to the one-month LIBOR will adjust monthly. A mortgage tied to the six-month LIBOR will adjust semi-annually.

You indicate that the interest rate is four percent. That makes perfect sense if your loan officer is offering you a margin of about two percent. Unless the program is something that is foreign to me, the problem you have is that this rate will adjust every six months.

This is your first question. I bet your bottom dollar that the four percent rate being quoted is good for only six months, not 10 years. If the rate goes up, your $330 saving will diminish quickly.

The question that you need to ask yourself is whether or not you want to take out a six-month ARM with a start rate of four percent to replace a 30-year fixed rate of 5.875 percent. If the ARM stays below 5.875 percent for the next 30 years, it would be a wise move. But there's no guarantee in that.

Here's another question: My calculator tells me that the difference in monthly payment between 5.875 percent and four percent is $242 per month with a 30-year amortization. Amortizations can't lie. As long as the LIBOR rate stays at four percent, your true savings are $242 per month.

However, most LIBOR-based ARMs allow an interest-only payment feature. This allows the borrower to pay only the interest charged for the month. The good news is that the payment will drop. The bad news is that you cannot curtail your loan balance if you make interest-only payments.

Paying interest only at four percent would drop your payment by $548 per month. I don't get it. How did your loan officer come up with a savings of $333?

Next question: Points. One point is equal to one percent of the loan amount. In your case each point charged will cost you $2,120 in non-refundable fees. Carefully consider doing business with a loan officer who cannot spell out the complete fees up-front. "Paying a few points" just doesn't cut the mustard. It rarely makes any sense to pay points when taking out an ARM.

Next question: Prepayment penalty. If, after reading this column, you still decide to jump on this fellow's LIBOR program, find out if there's a penalty for early pay-off.

As I said, I am a big fan of LIBOR-based mortgages. The rates are rising, as they were expected to do, but they are still quite low. An interest-only feature allows a borrower to use his funds for more practical purposes, rather than pay down a tax deductible, low interest mortgage.

But having said that, a LIBOR is not for everyone. If you are firmly planted in your house and already have a low fixed-rate mortgage, a LIBOR is not for you.

Published: August 26, 2004

Use of this article without permission is a violation of federal copyright laws.

, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.