An adjustable-rate mortgage reset can pose a serious threat to your home. Read along for information on the latest vital mortgage questions and moves you can make to keep your home financially secure.
1. What is a rate reset?
The first reset can be sharp and steep when rates have risen during the introductory period. The reason is twofold: your index, which determines your interest rate, is reset higher to reflect the current rate of interest and your mortgage company adds on its margin. This margin is an extra percentage point or two for them. Both index and margin components then continue for the term of the loan.
2. How do I know if my rate will reset?
If you have an ARM, by definition your rate will reset on one or more of the ‘change dates’. The largest rise comes at the end of the introductory rate period. For instance, a 3/1 ARM will reset after the first three years, a 5/1 ARM after the first five years and so on.
3. How much will my rate reset?
The rate reset amount is defined by the mortgage contract to be a factor of three components: the index, the margin and the limit (cap).
Index: This is based on the interest rate or bond yields in other markets. Typical indexes used in ARMs include: COFI (cost of funds index, based on Western U.S. banks), MTA (monthly Treasury average of one-year Treasury bills), LIBOR (London Interbank Offered Rate, the wholesale bank money market rate in London) and CMT (constant maturity Treasury bill average).
Margin: A service fee charged by the mortgage company.
Cap: places limits on the maximum percentage your mortgage rate can be raised in a given period. Typically, an ARM will limit the initial reset, subsequent annual resets (periodic cap) and the maximum (lifetime cap) increase for the term of the loan.
4. What should I do before my rate resets?
It is always better to be forewarned. You should figure out exactly what your new reset mortgage payment should be days in advance so you can prepare accordingly.