A mortgage reset is sometimes part of a balloon mortgage and it has several features. Generally when people first obtain their mortgage, they might have the option to pay much lower interest rates or make interest only payments for the first few years of owning the home. However, at a specific point, either the entire amount of the mortgage becomes due or the mortgage is readjusted and reset with a higher interest rate. This can dramatically increase monthly payments, and the mortgage reset certainly contributed to higher foreclosure rates in the latter part of 2000 because of many lenders’ inability to make larger monthly payments.
One of the reasons the balloon mortgage became so popular was that some people were able to borrow more money and purchase more expensive houses initially. Ability to afford payments based on income was calculated on the basis of the payments prior to the mortgage reset. Many people could reasonably afford payments at pre-reset levels, but weren’t able to do so when the balloon payment or reset option had to be exercised.
Moreover, when people pay interest only loans, they are not building any equity in their home. Home values declined in the late 2000s, and lots of people quickly had upside down mortgages. They owed more than their homes were worth, and couldn’t sell them to completely pay off a mortgage. Refinancing became difficult too because amount people needed to borrow exceeded the value of their homes.
Another form of reset mortgage caused greater foreclosure rates. The option ARM (adjustable rate mortgage) could allow some borrowers to avoid paying full interest payments for the introductory period of the loan. This meant borrowers actually added to the debt they owed each month and immediately put their mortgage in an upside down state.
Sometimes the mortgage reset operates gradually. The introductory rate is short, perhaps less than a year, and then interest rates are raised every half year or so, and usually far exceed the prime interest rate. This can ultimately mean people pay far more in payments and these payments can continue to increase on a regular basis.
The standard option for many people who hit the mortgage reset period is to seek refinancing to a lower interest rate, which helps to keep payments stable. However, this low rate may still be more than a borrower can afford, and banks have considerably tightened lending restrictions since the late 2000s. Obtaining refinancing unless credit rating and history are excellent, and unless a person can prove they will meet the payments, may be very difficult. Many people find the only option is foreclosure and they lose their homes.
Those thinking about a mortgage with any form of reset should consider their ability to afford payments once resets occur and whether they would be able to get refinancing for a mortgage that suddenly becomes due. These types of mortgages may be harder to find now too, because they have proven so problematic for the housing market and lending industry. Most people are better off obtaining mortgages that have stable and predictable payments and that manage to increase equity in the home with each payment.