Mortgage horror: ARM reset time

One of my friends is worried because he's got an Adjustable Rate Mortgage (ARM) on his home and it's going to reset later this year. He's got an unusual financial situation, and hasn't been able to find a company that will refinance the house. Of course, he's worried that once the ARM resets, his interest rate will skyrocket and won't be able to afford his house anymore.

I had heard that resets aren't always bad, so I was interested in looking at his mortgage documents and finding out what was going to happen to him. His current rate on the mortgage is 5.75%, and the ARM will reset on December 1. The interest rate will then be adjusted once per year, with a maximum rate of 10.75%. On each renewal rate after the first one, the rate can't go up more than 2%.

So what's that initial reset rate going to be? The loan documents specify that he pays 2.25% plus the 1 year LIBOR rate. The LIBOR rate is currently sitting around 3%, which would make his new rate 5.25% if it was resetting today. That's not bad at all, and probably even better than he'd get if he cold find a bank to lend to him at a fixed rate today. A year ago, the LIBOR rate was around 5.5%, which would have given him a rate of 7.75%. That's not so good, but it's not the end of the world either.

See ... not all ARM resets are devastating. My friend will probably be just fine when reset day comes along, and that rate will be fixed for the next year. He's got plenty of time to look for other mortgage options during that time, and possibly he'll be able to find a fixed rate to lock in.

Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.