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Pete Sabine's Blog

By Pete Sabine | Broker in Lafayette, CA

Adjustable Rate Loans


Most, if not all, adjustable rate and interest only loans have what is known as a “reset” feature that will automatically modify and restructure an existing loan under pre-determined guidelines set forth in the original loan documents.


The typical loan reset is triggered by a specific date, usually at the end of the first five years of the loan term, or by the increase in the original loan amount due to negative amortization adding to the loan balance. The loan balance increase will vary depending on the reset terms and the typical range is 115% to 125% above the original loan amount. The reset will trigger by the earlier of either one of these two trigger events.


In most loan resets, the note interest rate (the adjustable rate index plus the margin) is changed to the prevailing market interest rate at the time of the reset. The loan is “recast” using the adjusted note interest rate and the current existing loan balance at the time of the reset. Additionally, the loan is recast on a 25 year amortization schedule as 5 years has already passed on a 30 year loan at the point of which the loan is reset.


When a loan is reset where there has not been any reduction of principle, or worse, negative amortization has increased the original loan balance, and using a higher note interest rate with a shorter amortization schedule, the monthly payment will increase to a level beyond the borrower’s capacity to pay.


This formula is a recipe for disaster and is the leading cause for the current explosive and exponential growth in foreclosures, short sales, bankruptcies and declining property values.


The most simple and effective solution to this run away freight train is to recast the loan at the time of a reset using a fifty year loan term.


Here is an example of how it works:


Original loan amount: $500,000

Fully indexed original interest rate: 5.5%

30 year loan term

Monthly loan payment = $2,673


Under typical reset guidelines:

Current loan amount: $588,000 (115% of original loan amount due to negative amortization)

Adjusted note interest rate: 6.5% (example prevailing rate)

25 year loan term

New monthly payment = $3,948


Under modified reset guidelines:

Current loan amount: $588,000

Adjusted note interest rate: 6.5%

50 year loan term

New monthly payment = $3,297


The difference in the reset monthly payment using the same interest rate and loan amount with a fifty year loan term is $624.


This solution is a win-win for the lender, the property owner and the investor who purchased a mortgage backed security investment tied to this loan.


  • The lower monthly payment dramatically increases the borrower’s ability to handle the added expense.
  • The bank is less likely to take a huge loss through a short sale or a foreclosure.
  • The investor maintains the yield on the mortgage security investment tied to the loan.


With fewer properties added to the unwieldy inventory of unsold properties, it will accelerate the time it takes to turn around the supply and demand imbalance to shore up property values.


This solution can be achieved without any further interest rate cuts by the Fed which is rapidly devaluing our dollar against foreign currencies and positioning our economy for a horrific battle with inflation over the next several years.


Be a part of this simple solution by contacting your local congressman or senator and urge them to initiate legislation to modify the terms of the reset features in adjustable and interest only loans.  Even if the modification enacted is a temporary moratorium on loan term resets, it can provide some time to breathe and provide substantial relief to this problem.


By the way, let’s not exclude real estate investors and non-owner occupied properties from this solution. The real estate investors suffer from the same maladies as home owners with the current loan reset guidelines.



 Pete Sabine
J Rockcliff Realtors
 (925) 385-2340

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