Get the FAQs on mortgage resets

Don't panic. Bankrate's got the information on today's most pressing mortgage questions, including moves you can make right now to keep your home financially secure.

Q: What is a rate reset?

A: Typically, when rates have risen during the introductory period, the first reset can be steep. That's because not only does your index, which determines your interest rate, reset upward to reflect current interest rates, but for the first time, your mortgage company tacks on its margin, an extra percentage point or two for them.

Both index and margin components then continue for the term of the loan.

Q: How do I know if my rate will reset?

A: If you hold an adjustable-rate mortgage, or ARM, your rate will reset by definition on one or more "change dates," with the largest hike coming at the end of an introductory or "teaser" rate period of anywhere between one month and 10 years.

For instance, a 3/1 ARM will reset after the first three years, a 5/1 ARM after the first five years and so on.

Although an ARM typically will continue to reset, often annually, after that initial hit, the yearly increases, also defined by contract, aren't likely to sting as much as the first reset. Your mortgage company may notify you prior to the reset and/or send new payment coupons reflecting your new monthly mortgage payment.

Don't know if you have an ARM? Find out.

Q: How much will my rate reset?

A: The amount of your rate reset as defined by your mortgage contract is a factor of three components -- the index, the margin and the limit, or "cap."

The index, as its name implies, is based on the interest rate or bond yields in other markets. Typical indexes used in ARMs include a handful of acronyms: COFI (cost of funds index, based on Western U.S. banks), MTA (monthly Treasury average of one-year Treasury bills), LIBOR (London Interbank Offered Rate, the wholesale bank money market rate in London) and CMT (constant maturity Treasury bill average).

The margin is an additional percentage that your mortgage company charges for its service.

The cap places limits on the maximum percentage your mortgage rate can be raised in a given period. Typically, an ARM will limit the initial reset, subsequent annual resets (periodic cap) and the maximum (lifetime cap) increase for the term of the loan.

When your mortgage "change date" arrives, your rate will adjust to the index interest rate on that day, plus an additional margin percentage as specified in your mortgage.

For instance, let's say you have a 3/1 ARM at an introductory rate of 5 percent. The index interest rate on your mortgage has risen to 7.5 percent after three years and the margin rate in your contract is 1.5 percent. Starting in the fourth year, your 5 percent ARM would reset to 7.5 percent with a 1.5 percent margin, for a new mortgage rate of 9 percent.

Confused? Walk through our ARM contract primer to help clarify your own mortgage.

Q: What should I do before my rate resets?

A: Forewarned is forearmed, especially where an impending mortgage reset it concerned. Grab your mortgage and sit down with our easy-to-use mortgage reset calculator to figure exactly what your new reset mortgage payment will be.

If your change period is still a ways off, you can track your ARM's index on Bankrate as well. That way, you'll be better able to determine your best move before time limits your options.

Q: What if I have a rate reset that is more than one year away?

A: With that kind of lead time, you have a number of options. You may decide to begin saving now to help cushion the blow of those stepped-up payments. If the monthly nut will still be too high, you might consider refinancing. You may take in a roommate to help with the heftier note.

Another option may be to sell now, before the change date gets uncomfortably close. We can help you calculate how much house you can afford.

If your local housing market makes the prospect of selling unappealing, you might consider co-ownership with a parent or other willing investor, especially if there is a good likelihood that your income may one day enable you to buy them out.

Q: What should I do if my rate has already reset?

A: That depends. If you can afford the higher rate, you may choose to simply continue making the higher monthly payments. Or you might find it more comfortable to refinance into a fixed-rate mortgage, especially if your credit is good and you plan on staying put.

Despite the housing slowdown, mortgage rates remain attractively below the 8 percent average for the past 20 years and lenders are eager to write, the subprime market excepting.

Check out up-to-date 15- and 30-year fixed-rate mortgages.

Q: What do I do if I can't afford my new payment?

A: Several avenues may be open to you, depending on your situation. The first step is to call your mortgage servicer's collections department. Here's how to prepare for that call.

If your shortfall is temporary, they may be willing to allow you to make partial payments until you can bring your account current. If your shortfall is due to a natural disaster or job loss, they may even grant you forbearance for three to six months, during which no payments are required, if you can convince them that you will be able to resume full payments and bring your account current after that period. The effect of these options on your credit rating is minimal to moderate.

From there, your options narrow, and you'll take them up with the servicer's loss mitigation department. To preserve their investment, they may be willing to modify the terms of your loan, perhaps by removing some of the fees or converting it from an ARM to a fixed-rate loan.

By the time foreclosure appears imminent, your options narrow further. The lender may offer to accept from you a deed in lieu of foreclosure, enabling them to take possession and sell the house, at their expense.

They typically prefer instead to allow a "short sale," in which you sell the house for less than you owe, at your expense.

The advantage of these two options: the impact on your credit rating, while severe, won't haunt you for seven years the way a foreclosure will. When the lender forecloses, they take possession, evict you and sell the house. All you have to show for it is a devastated credit record.

Q: What if I owe more than my house is worth?

A: If you find yourself "upside down" in your home, you're not alone; a Bankrate survey indicates that 4 percent of U.S. homeowners, or about 3 million of the 75 million homeowners, are in the same sinking boat.

The situation is vexing because it prevents you from refinancing, borrowing against equity (there isn't any) or selling the home without making up the shortfall out of your own pocket. The only way to right your situation is to pay down debt and begin to build equity.

Doing this may involve any of the following belt-tightening measures: find additional income through overtime or a second job, temporarily suspend all 401(k), IRA and 529 college contributions, reduce your paycheck withholding, eliminate nonessential services such as cable TV and high-speed Internet and live within a strict budget that frees up the capital to dig out of the hole.

Tough? Sure. But it beats losing your home to foreclosure. Read how Bankrate's Senior Financial Analyst Greg McBride helped one single mom get her financial life right side up.

Q: What if my lender goes bankrupt or stops lending before my loan closes?

A: Your mortgage loan may still be viable, even if your lender isn't. When a lender goes under, the court orders it to sell its assets to pay its creditors. That means another lender could well assume your loan.

But the timing of all this could be problematic for you and your impending close date.

First, call the lender to determine if it intends to make good on the loan, and if not, who will? Second, if the lender is unresponsive, call your state's banking official and ask who is taking over the lender's loans. Third, if you used a mortgage broker, call them as well; they may be able to find you substitute financing quickly. Finally, if no acceptable substitute loan offer is forthcoming, you may have no choice but to start over and reshop your loan.

Q: What if my lender goes bankrupt after my loan closes?

A: Two scenarios are likely. If your mortgage has already been turned over by the loan originator to a loan servicing company (a common practice today), you may not even notice that the loan originator, or the company to whom they sold your loan, has gone belly-up.

It may be business as usual with your mortgage bill, while behind the scenes, your mortgage is being acquired by another lender through government-sponsored housing enterprises such as Fannie Mae, Freddie Mac or Ginnie Mae.

If your lender is servicing your loan when it goes bankrupt, chances are a new lender or a loan servicer will contact you shortly. By federal law, your previous lender is required to notify you within 15 days of any change in servicing, including effective date and complete contact information of your new mortgage service.

To avoid scams, be sure to compare the notices you receive from your old and new firms, and if there are discrepancies, do not send a payment to the new firm until you verify that it is your new loan servicer.

Q: If my lender goes bankrupt, can I stop repaying? Could I have to pay off my mortgage at once?

A: Your mortgage is a secure and binding legal contract, as well as a valuable asset to your lender. Even though the company that originated the loan subsequently sells it or goes out of business, you remain legally obligated to repay the loan over the contracted period.

Subsequent owners of your mortgage loan are similarly required to honor the contract, and therefore cannot change its repayment terms. If you have paid off your loan and want to obtain mortgage satisfaction documents from your bankrupt lender, call or write your state's Attorney General. They should be able to identify