NEW YORK (CNNMoney.com) -
In the past few years, nearly a third of all mortgage loans have been in the form of adjustable rate mortgages (ARMs).
Now, it's time to pay the piper.
There are several types of ARMs but all share one feature: After an initial period of fixed payments with low rates, the loans adjust -- usually to the prevailing yield of one-year Treasury bills plus a margin of one to three percentage points.
For example, a borrower with a 3/1 ARM pays at the initial interest rate for three years and the loan adjusts once a year after that. A one-year ARM, which has a lower initial rate, adjusts after one year and a 5/1 adjusts after five. There are also 7/1 and 10/1 ARMs.
People who took out a 3/1 ARM in late 2002 or early 2003 will soon get socked with big increases in their monthly mortgage payments.
The Mortgage Bankers Association estimates that some $330 billion worth of ARMs will adjust in 2006 and $1 trillion worth will reset by the end of 2007.
Since the average ARM loan is about $300,000, according to Freddie Mac, a trillion dollars probably represents more than 3 million homeowners who will face bigger bills in the next two years.
If you took out an 3/1 ARM for $300,000 back in late 2002, your initial interest rate was probably around 5 percent and your monthly payment has been about $1,610.
Keith Gumbinger, vice president at HSH Associates, a publisher of consumer loan information, says 3/1 ARM coming due today would readjust to a rate of 7.1 percent, a jump of more than 2 percentage points. (Most 3/1 ARMs, however, have 2 percentage point caps; they can't be raised more than that until they readjust after another year).
Your new payment: $1,995 a month -- a difference of $385, or more than $4,600 a year.
One-year ARM holders, whose initial rates last year were just over 4 percent, will also see their payment increase a lot, but because of caps, they still won't be paying as much as 3/1 ARM holders, at least until they reset again.
Holders of 5/1 ARMs coming due later in 2006 and in early 2007, should not have to undergo increases as big. Their rates were higher to begin with, about 6.6 percent in early 2002; going to 7.1 percent would only add about $100 to their monthly payments.
Gumbinger says, "Most borrowers have some financial cushion so the impact won't be immediate; spending an extra $380 is manageable at first. But it's safe to say there are some who will find themselves in budgetary difficulties a year or two down the road."
Refinance into a fixed rate
Many ARMs holders are transferring their debt into fixed-rate mortgages, according to Bob Moulton, founder of Americana Mortgage Group on Long Island. This will shield them from further rate increases, but it does entail a bit of sticker shot as well.
A 30-year fixed rate at 6.43 percent will still add about $260 a month to the borrower who had a 3/1 ARM. And the borrower will either have to pay about $3,000 to $5,000 in closing costs out of pocket or add that sum to the mortgage principal, sending monthly bills higher.
ARM borrowers got the benefits of low initial payments, but now they're going to pay the price. It could mean added pain for a real estate market looking a bit shaky after years of good times.
Real estate prices may have plateaued. Click here for more.
A cooling market may not be such a bad thing. Click here for that story.