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What to Expect When Your ARM Resets

By manybanking.com Staff
You bought at the top of the market and used an adjustable rate mortgage (ARM) to finance your loan. You figured you would just refinance when the fixed rate period was over. But now that home prices have fallen so dramatically, it’s harder to refinance. So what do you do if your ARM is about to reset?

Category Product: 
Mortgages
Category Finance: 
Personal Finance
Keywords: 
Adjustable Rate Mortgages, ARMs, Mortgages, Home Loan, Owning a Home, Lending, Buying a Home, Interest Rates, Selling a Home, Yield
Introduction: 

By manybanking.com Staff
You bought at the top of the market and used an adjustable rate mortgage (ARM) to finance your loan. You figured you would just refinance when the fixed rate period was over. But now that home prices have fallen so dramatically, it’s harder to refinance. So what do you do if your ARM is about to reset?

This is a question that many homeowners are now facing. Adjustable rate mortgages allowed many people to afford homes that would have been beyond their reach using a fixed-rate loan. These loans typically feature a low introductory, or “teaser,” rate that is fixed for specified period, usually two, three or five years. After that, the interest rate and monthly payments adjust. How much the interest goes up is calculated by adding the agreed upon margin to an index such as the London Interbank Offered Rate (Libor). The size of the margin typically depends on the credit worthiness of the borrower.

When home prices were rising, homeowners were able to easily refinance out of adjustable rate mortgages before they got any payment shock from the interest rate resetting higher. But now that home prices have fallen, down 18.6 percent according to the S&P Case-Shiller Home Price Index, refinancing may be impossible for some. The problem is, many homeowners don’t have enough equity to refinance. Most of those who used ARM mortgages only paid the minimum necessary payment (often interest-only) and put little or nothing down. Consequently, a large percentage of them are underwater on their mortgages.

While the tumbling housing market has triggered this problem, the rocky economy may actually offer a reprieve. Thanks to record low interest rates, the “ticking time bomb” of ARM resets hasn’t actually exploded. A few years ago, when the Libor Index was over 5%, an ARM with a margin of 5% would reset at over 10%, resulting in drastically higher monthly payments. Today, the Libor Index is under 2%, so an ARM with a margin of 5% would adjust to less than 7%. Some low-risk borrowers who have lower margins may actually see their interest rate go down in the current low-rate environment.

That means if you have an ARM that is about to reset, you should be looking at the margin to find out just what it will reset to. Use manybanking.com’s Adjustable Rate Calculator to crunch the numbers. If you have a low margin, you may be fine in the short run. You should also look at your ARMs adjustment schedule. If your ARM adjusts once a year, you’ll have at least a year to try sort things out while your interest rate remains low. You may be able to qualify for refinance assistance through the government’s Home Affordable Refinance program. If your ARM adjusts monthly, you may not have as long. For now, there doesn’t seem to be any upward pressure on interest rates, but things could change.

Those who have Option ARMs (negative amortization loans) are in worse shape. While many of these loans will not reset immediately, when they do, payments will still rise sharply. With Option ARMs, payments are often so low the interest is not covered and the remainder is added to the principal. That means homeowners become accustomed to paying very low monthly payments and become even more underwater than most ARM borrowers. When these rates do reset, as many will next year, the payment shock will likely cause a new wave of foreclosures.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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This is a question that many homeowners are now facing. Adjustable rate mortgages allowed many people to afford homes that would have been beyond their reach using a fixed-rate loan. These loans typically feature a low introductory, or “teaser,” rate that is fixed for specified period, usually two, three or five years. After that, the interest rate and monthly payments adjust. How much the interest goes up is calculated by adding the agreed upon margin to an index such as the London Interbank Offered Rate (Libor). The size of the margin typically depends on the credit worthiness of the borrower.

When home prices were rising, homeowners were able to easily refinance out of adjustable rate mortgages before they got any payment shock from the interest rate resetting higher. But now that home prices have fallen, down 18.6 percent according to the S&P Case-Shiller Home Price Index, refinancing may be impossible for some. The problem is, many homeowners don’t have enough equity to refinance. Most of those who used ARM mortgages only paid the minimum necessary payment (often interest-only) and put little or nothing down. Consequently, a large percentage of them are underwater on their mortgages.

While the tumbling housing market has triggered this problem, the rocky economy may actually offer a reprieve. Thanks to record low interest rates, the “ticking time bomb” of ARM resets hasn’t actually exploded. A few years ago, when the Libor Index was over 5%, an ARM with a margin of 5% would reset at over 10%, resulting in drastically higher monthly payments. Today, the Libor Index is under 2%, so an ARM with a margin of 5% would adjust to less than 7%. Some low-risk borrowers who have lower margins may actually see their interest rate go down in the current low-rate environment.

That means if you have an ARM that is about to reset, you should be looking at the margin to find out just what it will reset to. Use manybanking.com’s Adjustable Rate Calculator to crunch the numbers. If you have a low margin, you may be fine in the short run. You should also look at your ARMs adjustment schedule. If your ARM adjusts once a year, you’ll have at least a year to try sort things out while your interest rate remains low. You may be able to qualify for refinance assistance through the government’s Home Affordable Refinance program. If your ARM adjusts monthly, you may not have as long. For now, there doesn’t seem to be any upward pressure on interest rates, but things could change.

Those who have Option ARMs (negative amortization loans) are in worse shape. While many of these loans will not reset immediately, when they do, payments will still rise sharply. With Option ARMs, payments are often so low the interest is not covered and the remainder is added to the principal. That means homeowners become accustomed to paying very low monthly payments and become even more underwater than most ARM borrowers. When these rates do reset, as many will next year, the payment shock will likely cause a new wave of foreclosures.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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