Will your adjustable rate mortgage payment go up?

Sometimes I am very afraid for Americans with home loans. If you look at the bankrate.com study – you know the one where 57% of mortgage holder said they have fixed rates – it is easy to see that too many Americans don’t know much about their mortgages. The reason the 57% number is so alarming is that nearly 3 out of every 4 subprime mortgages written between 2005-2006 were adjustable rate mortgages. And there are a number of statistics about the number of ARM loans written in the prime market as well. It all points to a very clear fact: most Americans don’t understand their mortgage.

This point was driven home the other day when one of the readers of this site sent me an email asking the question: "I just got a notice that my interest rate will be adjusting this fall. Do you think my payment will go up?" That was it. I don’t know the loan type, the rate of the loan, the index it’s tied to, the margin, anything. I don’t have a clue what type of mortgage this is. But, if I was a betting man (heck even if I wasn’t) I’d say yes its going up.

Most ARMs have a "teaser" start rate, and when they adjust they can reset to a much higher interest rate. The higher rates are based on an index, a margin (a fixed amount over the index) and are limited by "caps" placed on interest rate changes in place on the change dates and over the life of the loan. Below is my response to the email in hopes that it will help you all here.

The short answer is: yes, it will probably go up. Most of the indexes that adjustable mortgages are based on have all moved up significantly in the past couple of years.

The longer answer: Most adjustable rate mortgaes are based on an index + a margin. Those indexes are usually the LIBOR index, the MTA index or the COFI index. You can learn more about the indexes at www.bankrate.com.

The index your loan is based on is listed in your mortgage note, usually in the Adjustable Rate Rider. The margin value is also listed there. One other piece of information you’ll need are the adjustment caps, which are also in the Adjustable Rate Rider.

You need to take the index your loan is based on, plus the margin and determine what your new interest rate would be, then look at your adjustment cap and take the lower of those two numbers. That will be your new interest rate.

For example. If I have a two year adjustable rate mortgage currently at 5% and my payment is going to change in June. I need to find the three above pieces of information. If I learn that I have the following:

LIBOR index loan
Margin of 3%
First payment change cap of 5%

Then I can figure out the following: My first adjustment can not be more than 10% (5% currently plus a maximum first adjustment of 5% = 10%).

My actual adjustment will be LIBOR (currently at about 5.3) + my margin (3%) = 8.3%

Taking the lower of the two my mortgage will adjust to 8.3% in June.

You can find the current LIBOR index and an online calculator to help you with calculating your new payment in the Mortgage section.

Here is a good article in the New York Times about the issue.

The next the part of the puzzle is to use an online mortgage calulator and figure out your new mortgage payment by plugging in your remaining loan balance and your new interest rate. If you freak out, contact your mortgage specialist to disucss your options. I’m happy to give any advice as well and I won’t solicit you for business.

Once you find your new mortgage payment, don’t get too comfortable. You need to read the details of your Adjustable Rate Rider (in your loan documents) and find out the adjustment periods, the periods between each adjustment on your ARM. The periods can be monthly, every 6 months or a year. My standard advice would be if you have an ARM you don’t want to live with it in the adjustment phase – its too stressful and unpredictable to play roulette with your mortgage payments each month.

For another great post on knowing your mortgage, read Rhonda Porter’s advice on Rain City Guide.