When Adjustable Resets Go Good

When Frothing Developer moved to Las Vegas in 2004, he bought a condominium at Turnberry Place. Knowing that he was unlikely to spend more than 5 years in one place, he went out and got an adjustable-rate mortgage, or ARM. He got it at an initial rate of 5.25%.

Come next January, Frothing Developer’s mortgage rate is going to reset.

Now, you might think, from the sound of current discourse, that Frothing Developer is in a world of panic about the impending reset. You might be forgiven for expecting gunmen to show up on reset day with empty cash boxes for Frothing Developer to fill up. Such has been the increasingly hysterical tenor of the discourse on ARM resets this last year.

The Arizona Republic, for example, sternly defines the adjustments as follows:

Adjustable-rate mortgage “resets,” in which a low initial interest rate is converted to a higher rate, are expected to peak this month in Arizona…

The effect of a reset varies tremendously based on each loan’s specific terms, ranging anywhere from a slight increase in the required monthly payment to doubling it.

And further:

As of February, an estimated 157,000 adjustable-rate loans had yet to reach their initial reset dates in Arizona, according to economic research firm First American CoreLogic, based in Santa Ana, Calif. The total value of those Arizona loans was roughly $38.7 billion, company spokeswoman Meghan Donovan said.

So, let’s go look at Frothing Developer’s loan documents to calculate the horrible increase he’s about to get hit with:

“1 Year Libor + 2.25”

Let’s see. Libor is 3.29% . So that means the new rate will be…. 5.54%. My monthly payment will rise…3%.

The point here is that not all adjustable-rate mortgages are evil. Yes, there are still plenty of old option-ARM mortgages out there that will adjust beyond the ability of their borrowers. It’s extremely risky to borrow more money than you can afford to pay, and a lot of people are in over there heads.

But a LOT of people are not. Most of those adjustable mortgages are going to adjust more like mine is doing. But it doesn’t make for as good a news story. So you’re not going to hear much about them.


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