Escape the Reset Crisis with a Refinance

Pay attention to the details if you have an adjustable-rate mortgage (ARM). Many three-year ARMs are scheduled to reset during the next 18 months, and many homeowners aren't prepared for the drastic payment increase.

ARMs are mortgage loans with payments that fluctuate, based on various changes in the interest rate market. Because rates have been trending higher these past two years, consumers who have ARM loans have seen their payments go up because of higher interest charged on the remaining balance. One particular group of borrowers-those who took out ARMs with super-low introductory rates-is feeling the most significant impact.

Teaser rates not fun

To encourage people to take out loans, mortgage companies offered discounts on the first few years of interest. The so-called "teaser rate" ARMs worked great for those who sold before the special introductory rates expired; but for others, they've been absolutely disastrous. Much of the current housing crisis can be traced to homeowners with ARM loans whose payments spiked. Unable to make their higher payments, they defaulted on their mortgages and were pushed into foreclosure. Currently, millions of Americans have ARM loans with rates that are scheduled to "reset," or be recalculated, based on prevailing rates. When that happens, the monthly payments on those mortgages will rise dramatically.

Important mortgage questions

If you have an adjustable-rate mortgage, chances are that you'll be adversely affected by this wave of payment adjustments. To dodge this bullet, it's imperative that you understand what kind of loan you have, and do whatever you can to switch from the volatile ARM into a more manageable, predictable mortgage. Study the small print, or have your attorney or financial advisor do so, and look for details that answer these questions:

• Is your mortgage an ARM?
• Do you have any second mortgages? Do those have adjustable rates?
• Is the ARM scheduled to reset? When does your current rate expire?
• Does your lender impose any penalties if you pay off the loan early?

Refinance to safety

For most people, refinancing from an adjustable-rate to a fixed-rate mortgage is the easiest solution, and the process is relatively simple, as long as you can qualify. One drawback is that lenders are much more conservative than they were before this mortgage meltdown, and qualifying for a basic refinance has become more difficult. Mortgage companies now require better credit, higher income, and stronger property values. Two years ago, for example, you could walk into a bank and borrow more than 100 percent of the market value of your home. Today, lenders are more inclined to let you borrow a maximum of 75 percent. If your home has lost value, your ability to borrow against it has also taken a hit. Housing prices recently posted the biggest year-to-year drop in more than 15 years, so the average homeowner's equity is rapidly evaporating.

The bottom line is this: If you have a troublesome ARM and need to refinance, don't procrastinate in 2008.