523,000 mortgages scheduled to reset in 2009

There are 523,000 adjustable prime mortgages set to adjust in 2009, and many of the indexes that determine their rates have been declining during the last few months.

The ARMs - 3/1 and 5/1 hybrids - were taken out during the housing-boom years of 2004 to 2006. Now, they are scheduled to do what adjustable-rate mortgages do.

This leaves these half-million homeowners with a critical question: Will the mortgage payments on these hybrids increase or decrease?

"These loans had introductory rates that lasted for three or five years; after that, the rates reset annually," said Holden Lewis, a columnist for Bankrate.com. "The date of that first rate reset peaked in the summer of 2008, but about half a million prime borrowers will see their first reset in 2009."

The half-million figure does not include option ARMs - mortgages with low introductory rates and a choice of monthly payments tailored to the borrower's income.

According to Rick Sharga, chief economist of RealtyTrac Inc., the Irvine, Calif., firm that tracks foreclosure filings, between $60 billion and $70 billion of these "exotic" adjustables could reset earlier than anticipated because of home-price depreciation.

The scheduled 2010 reset of these loans might begin in April of this year "because of triggers in the mortgages that cause an automatic reset if the loan-to-value ratio hits 115 or 120 percent," he said.

Since about 95 percent of these borrowers "have been paying the interest-only option or, worse, the negative-amortization option, their payments will go up as well, probably with disastrous results," he said.

The half-million hybrid ARMs adjusting in 2009 do not include subprime loans, according to Lewis.

Keenan Okolichany, 32, of Doylestown, had a 5/1 hybrid with a 5.25 percent teaser rate that was scheduled to reset in August. He was not eager to find out whether his payments would rise or fall.

"We'd heard a rumor that rates would drop to 4.5 percent, but were told that it wasn't likely to happen," said Okolichany, who locked into a 30-year fixed rate at 5.125 percent, saving $122 a month on his payment.

Despite the decline in some of the indexes to which the rates on some of these loans are tied, owners shouldn't bet the farm that theirs will drop.

"Some borrowers who might have gone into default due to a more significant increase in monthly payments will likely be spared" by the lower indexes, Sharga said.

Conventional wisdom is that if your rate is scheduled to reset and you meet the qualifications required to refinance at a fixed rate, which is now averaging a 38-year low of 5.01 percent, you do so, said Jerome S. Scarpello, of Leo Mortgage in Ambler.

If you plan to stay in your house for a couple of years more, you probably can live with the reset payment. If not, consider refinancing, said Philadelphia mortgage broker Fred Glick.

What happens to your adjustable rate will depend on the index used to determine the rate and the margin the lender charges, Glick said. He warns that some lenders can switch indexes on borrowers, if it was so specified in the original agreement.

The interest rate on an ARM is made up of two parts: the index and the margin. The index is a measure of interest rates generally, and the margin is an extra amount that the lender adds.

Sometimes limits or "caps" will keep the interest rate on a mortgage from resetting fully. If the rate is supposed to increase 3 percentage points but can rise only 2 points in a year because of a "cap," it will rise just 2.

If the rate increase is 1 percentage point the following year, the lender will then "carry over" the percentage point from the previous year, which the cap had prevented from being applied.

"The caps work both ways, limiting rises and drops," meaning that if your loan comes with an annual limit of 2 percentage points, it applies to increasing as well as declining, Glick said.

So even if your rate is now 6 percent, and the index on your rate is now 1 percent and the margin is 2 percent, your 2 percent cap will drop you to 4 percent, not 3 percent, in theory.

There are several indexes used to determine adjustable rates, but among the most common are the one-year constant-maturity Treasury securities (CMT), the Monthly Treasury Average (MTA), the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR).

Some are "leading" indexes, such as the LIBOR, which reacts quickly to market changes. The MTA is a "lagging" index because it is an average of the 12 previous months of the one-year CMT, so rates change slowly.

"For borrowers who had teaser rates, the adjustment will still likely represent an increase," Sharga said. "If the teaser rate was 2 percent, anything higher than that will result in an increase, and industry speculation is that many of the borrowers with ARMs are likely to default if they get any increase."

Okolichany said that the 5/1 hybrid had represented a real savings from fixed rates (6.30 percent) in the summer of 2004, when he and his wife bought the house, and made sense because they and their three children had planned to move long before the ARM reset.

"The market changed, so we decided not to move," he said. "We've been here five years, and we'll probably be here five more" because of the low fixed rate.