ARM resets: what a first rate change does to your budget

If your adjustable-rate mortgage is about to reset, a knot in your stomach is normal. About 150,000 households get their first rate change this year, and for many the monthly payment may go up, CNBC reported, citing ICE Mortgage Technology data. Here is how big the change can be, when you will hear about it, and how to plan for it.

What is happening to adjustable-rate loans

An adjustable-rate mortgage, or ARM, starts with a fixed introductory rate, often for five, seven or 10 years. After that, the rate resets, usually every six months or once a year, in line with where rates are now.

Many of these loans began when rates were much lower. ICE counts 3.1 million ARMs outstanding, the most in 5.5 years, with 1.05 million already in the adjusting phase. After about 150,000 first resets this year, 186,000 are due in 2027 and 155,000 in 2028. ARMs are still a small slice of the market, at 5.6% of about 55.4 million active US mortgages.

How big the change can be

The size of the jump depends on the starting rate and on the loan's caps. ICE's figures show the gap clearly. Seven-year ARMs taken out in 2019 and resetting from August to December had a median starting rate of 3% on a median balance of $548,000. Their median new rate is 6.06%, and the median payment rises by $1,080 a month.

It does not always go up. Three-year ARMs from 2023 started at a median 8.38% and are set to fall to a median 7.71%, cutting the payment by $124.

Laurie Goodman of the Urban Institute's Housing Finance Policy Center described the trade-off borrowers made when they chose a lower starting rate and accepted that it could rise: "Well, unfortunately that scenario happened."

Reading your loan before the letter arrives

You do not have to wait for the lender to find out your worst case. Your loan papers list the caps. A typical example allows a rise of 2 percentage points at the first reset, 1 point at each later reset, and 5 points in total for as long as the loan runs.

Those three numbers tell you the ceiling. Add the first cap to your current rate and you know the highest rate your first new payment can carry. Add the lifetime cap and you know the most it can ever reach. That gives you a planning line.

• First notice: the Consumer Financial Protection Bureau says lenders must write 210 to 240 days ahead of the first new payment, roughly seven to eight months out, with an estimate based on current rates.
• Second notice: about 60 to 120 days before the new payment, showing the actual rate and the monthly amount.

The first letter is your planning window. The second one is the number to put in the budget.

A small step to take this week

Write down three things from your loan papers: when the fixed period ends, the first-reset cap and the lifetime cap. Then mark which budget lines could flex if the housing payment rises, and which cannot.

If you are thinking about refinancing into a fixed rate, count the cost too. Fannie Mae says closing costs are usually 2% to 5% of the loan, which on a $300,000 loan is $6,000 to $15,000. Kate Wood of NerdWallet said a fixed rate may suit people whom the adjustments would badly stretch, and that a strong credit score helps when asking for a lender's best rate. Others keep the ARM; Duane Buziak of Coast2Coast Mortgage said some can because their pay has grown, but not everyone can.

If the new payment looks out of reach, the CFPB says a housing counselor approved by HUD can guide you through requesting a repayment plan or a change to the loan terms.

What to watch next

Watch rates for new loans if you are weighing a switch. Bankrate puts the average starting rate on a 5/1 ARM around 6.65%, while Mortgage News Daily had the 30-year fixed average at 7.48%. And watch your mailbox for that first notice.