ARM Ready to Re-set? What to Do

by Nancy Osborne, COO of ERATE

It is estimated that about 1.3 million sub-prime adjustable rate loans are due to re-set by the end of 2008. If you were a recent homebuyer who took advantage of low interest rates and are now stuck with either an option ARM or an interest only loan and your first rate adjustment is looming on the horizon, what should you do? Relief from your lender may be on the way as many of the lenders who are saturated with these loans fear that adjustments for a high percentage of these borrowers may result in REOs (foreclosures) on their books. Fortunately many lenders are now being proactive in working with borrowers who may be at risk to halt these adjustments before they occur. But as an adjustable rate mortgage borrower you must take steps to avoid potential problems yourself by being ready for the rate change that is coming. Many adjustable rate borrowers will be caught off guard by the increase in their mortgage payment, which could be as high as a 50% jump in some cases, don't be one of them. Here's what you can do now:

> Find out what index your adjustable rate loan is tied to. This is the variable or adjustable component of the loan. Refer to your copy of the loan documents, hopefully you have maintained copies, or you may contact your mortgage loan servicer to determine this information. Most adjustables are tied to some variation of the treasury index or the LIBOR (London Interbank Offered Rate) index. Then find out where that index currently stands.

> Next determine what the margin on your loan is. The margin is the fixed component of a variable or adjustable rate loan. Again refer to your copy of the loan documents or contact your mortgage loan servicer to find out this information.

> Adjustables do have either an annual interest rate cap (the best case scenario) or a payment cap (the worst case scenario). Interest caps usually run at either 2% annually or 1% semi-annually. If you have a payment cap, this is where negative amortization can come into play. If your payment cap does not permit you to amortize (or pay off) the loan, then the difference is tacked onto your loan balance and rather than declining gradually over time as one would expect, your loan size could actually increase from the original loan amount borrowed.

> Once you have both the index and the margin, you can add the two numbers together to determine your new interest rate. Then use the applicable loan caps referenced in your loan documents to determine the maximum amount your rate could change. You can use your current mortgage balance to calculate your payment using your own calculator or one of the many readily available mortgage calculators on financial or real estate related websites.

> Next comes the decision to accept the rate and payment change looming if you can afford it or you may want to consider refinancing if you intend to stay in the property for at least 4-5 more years. If you cannot handle the payment shock that is coming and selling your home is not an option, then your best course of action is to contact your lender immediately to let them know your status and allow them time to work out a new payment solution that will suit your income and will prevent your lender from having to take the property back as an REO and sell it at a trustee or foreclosure sale.

  Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.