The Exploding ARM

01 Nov The Exploding ARM

An Adjustable Rate Mortgage, or ARM, easily can force a bankruptcy filing. We call it an “exploding” ARM, because the adjustment blows up the interest rate into the stratosphere, as most recent ARMs will do.

Five words will get you through an ARM: (1) an Initial Interest Rate, (2) a Change Date, (3) a Base Interest Rate, (4) a Margin, and (5) a Cap or Limit on Interest Rate Change. Adjustable rate mortgage documents do not always use these labels but they always have numbers fitting these concepts. On the Change Date, the interest rate will change from the Initial Interest Rate to the total of the Base Interest Rate and the Margin, subject to a Cap or Limit on Interest Rate Change which is can be 14% or higher in recent ARMs.

The Initial Interest Rate is the beginning mortgage interest rate and lasts until the first Change Date, which may be between one month and two years after the mortgage begins. The Initial Interest Rate can be the same as the Base Rate. If the Initial Interest Rate is lower than usual market rates, then it also is called a “teaser rate” and the mortgage broker says “Don’t Worry! You can refinance in two years before the adjustment because the value of your home will increase!!” You can also call this a “sucker rate.”

On the Change Date, the interest changes away from the Initial Interest Rate and becomes the total of the Base Rate plus the Margin. Sometimes this new Margin factor doesn’t even get named, but you’ll read it as the first component which is added to the Base Interest Rate to get to your new, exploded interest rate.

Index Rates are commonly LIBOR, the London InterBank Offering Rate. LIBOR is used because it is not subject to the regulation or control of the United States government.

A typical ARM will say that its interest rates have a Cap or Limit on Interest Rate Change. This is a joke in recent ARMs as it goes both ways. The cap is never lower than the higher of the Initial Interest Rate or the Base Rate. The cap is never higher than a very high interest rate, perhaps 14% or higher.

Recent ARMs only go up in interest; they never go down. And they go up a lot, much more than one’s income will go up. Under the now-ancient standard of a 28% ratio between a mortgage payment and income, one’s income would have to increase by more than 25% to afford a 5% mortgage payment increase. Anyone out there with an ARM going to see their income increase by 25% before the two year Change Date?

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L. Jed Berliner, Western & Central Massachusetts Consumer Lawyer

L. Jed Berliner practices exclusively in consumer bankruptcy, foreclosure defense, and related consumer protection litigation such as credit card defenses and suing debt collectors. He established his Springfield, MA practice in 1988. Attorney Berliner is a regular and active contributor to the Bankruptcy Law Network, the Bankruptcy Roundtable, and the National Association of Consumer Bankruptcy Attorneys, three specialized consumer bankruptcy forums on the Internet, and is an informal mentor to regional practitioners. He is recognized by his peers as an expert in consumer bankruptcy issues. He thoroughly enjoys being rated "excellent" in his client surveys.

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