A year or so ago, people were refinancing to get a lower interest rate. Today more and more people are refinancing to avoid getting stuck with a higher rate. It's not as if mortgage rates are really high right now -- not to people who can remember paying 8 percent or even 10 percent or more. But rates are definitely not as low as they were a year ago, which is why people are not refinancing their 30-year, fixed-rate mortgages.

More and more people, however, are refinancing their adjustable-rate mortgages, or ARMs, home equity lines of credit, or HELOCs, and other loans with variable interest rates that could scoot up on them, especially those pegged to the more volatile financial indexes.

In my mind, rates really haven't gone up significantly,” says Adam Waldman, sales manager for Home Finance of America, in Plymouth Meeting, Pa. “Historically, we're less than 1 percent off all-time lows, so in terms of the big picture, rates haven't really gone up all that much. People see the interest rates on their home equity credit lines going up, though. If there is a rush to refinance, it is to get rid of the lines of credit and lock into a fixed rate.” It's the same with many ARMs and other nontraditional loans that have adjustable interest rates. “What was 4 percent two years ago is now 7 percent in many instances.”

Waldman says that based on his company's business with borrowers across the country, a lot of people are justifiably nervous that rates could go even higher, and they are looking for stability. “They are looking to sleep a little bit better at night.”

While a 30- or 15-year fixed-rate loan will stay the same no matter what other interest rates do, loans with interest rates that adjust at various times during the life of the loan can and do change. The interest rate on a one-year ARM, for example, can change at the end of one year, and could change every year thereafter. A three-year ARM can change after three years, and so on. Most ARMs have caps and ceilings limiting how much the interest rate can jump at any one time as well as how high it can climb over the life of the loan. Even with those safeguards, some borrowers are in for some nasty increases, and many of them are facing them right now.

Let's look at some examples. A $100,000 loan at 4 percent has a basic monthly payment of $477.42. That is for interest and principal only, and does not include insurance, taxes or any fees or assessments. At 5 percent, the basic monthly payment is $536.62, another rate that was fairly easy to get a year or so ago. At 6 percent the payment is $599.55, and at 7 percent it's $665.30. A 1-percent hike, from 4 percent to 5 percent, would cost an extra $89.20 a month, or $1,070.40 a year -- an increase of 12.3 percent. Jump it from 4 percent to 7 percent and you face a 39.4 percent hike that would cost the homeowner an extra $217.87 a month, or $2,614.44 a year.

The interest rate on an ARM or a HELOC is usually pegged to a specific financial index, which should be spelled out in the loan document. The exact date of the rate adjustment is also listed. Popular indexes include the Treasury Constant Maturity, or TCM, on the one-year Treasury bill, the 12-month TCM average on the one-year T-bill, the London Interbank Offered Rate, or LIBOR, and the cost of funds index, or COFI, among others.

Some of these indexes are more volatile than others, based on a wide variety of factors ranging from the current interest rate on Treasury bills to what the Federal Reserve Board is doing. As a result, an ARM or HELOC pegged to one of these indexes might be adjusted to a different rate than an otherwise identical loan pegged to a different index. For that matter, two adjustable-rate loans pegged to the same index might move by different amounts if they are adjusted on different dates. The adjustment depends upon where the index is on the adjustment date.

The people who stand to get hit the hardest by rate increases are those who borrowed as much as they could when they took out their loans and wound up with the largest monthly payments they could qualify for at the time. The question now is: Can they afford an even larger monthly payment?

These people have two main options. One is to get another ARM and take advantage of the initially lower rates they offer. The other is to look for the best long-term loan available -- a 15-, 20- or 30-year conventional fixed-rate loan -- so they don't have to go through the stress, aggravation and expense of refinancing in another year or so.

The expense of refinancing is reflected in the annual percentage rate, or APR. The APR tells you the amount you actually pay for a loan when you include the fees and charges that are part of the cost of getting the loan. Today, in most cases, the difference between the APR for a one-year ARM and a 30-year conventional loan is less than 1 percent. While a typical one-year ARM has a posted rate of 4.03 percent, the APR raises it to 5.04 percent. The posted rate for a 30-year loan could be 5.875 percent with an APR of 5.942 percent.

Waldman says that a lot of people “want to get out of a scary or uncomfortable rate that can continue to change their monthly payment.” They want to lock into something that won't change, no matter where mortgage rates go.

Waldman also observes that more and more people are rolling their first and second mortgages into one loan. Others are combining their first mortgage and their HELOC.

“It is still an attractive time to roll some debt into a longer-term loan,” says Waldman. When people combine loans they usually wind up making one payment that is smaller than the combined total of the original two -- or more -- old payments. “People today are afraid rates can go even higher.”

Stef Donev is a Southern California freelancer who writes for Interest.com and who has been covering the mortgage industry and other consumer finance issues for nearly a decade. Interest.com is a national publisher of mortgage rates & information. 

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Risky Arm Mortgages come due

Higher mortgage payments are squeezing more homeowners.

Not because they've bought bigger homes or tapped their equity by taking out second mortgages but because the superlow "teaser" payments that drew them into their adjustable-rate mortgages are quickly disappearing.

Thousands of people used the non-traditional mortgages last year to afford a house in the Valley, where home prices increased nearly 50 percent from 2004. They're paying for that decision today.

On many adjustable-rate mortgages, or ARMs, the interest rate adjusts twice a year after the teaser period.

As a result, each year, the monthly payment on a loan for a $250,000 Valley home could climb by more than $100.

Arizona incomes aren't climbing at the same rate, meaning many of those already struggling to pay their mortgages could wind up losing their homes in the months ahead.

Arizona's housing market could be hurt more than other areas of the country by a fallout from rapidly rising rates on ARMs.

Economists say nearly 40 percent of all home loans in metropolitan Phoenix are adjustable. Nationally, about 30 percent of all mortgages are ARMs.

Making the situation potentially worse for Arizona's housing market, the number of subprime ARMs jumped by 50 percent in the state last year, the Mortgage Bankers Association of Arizona reports. Subprime loans, which carry high interest rates, typically are taken out by borrowers with poor credit histories.

Adjustable-rate mortgages offer low introductory interest rates that quickly and frequently climb based on a rate and index set by the lender. Unlike traditional, fixed mortgages, those indexes are closely tied to the interest rate that the Federal Reserve has hiked 15 times in the past two years.

"Record numbers of people lured by low initial teaser rates have taken out adjustable-rate mortgages that are putting them in vulnerable positions as rates rise," said Jay Luber, a vice president with First Horizon Home Loans in Phoenix.

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Refinancing ARMs

Some homeowners, like Mary and Michael Gotway of Paradise Valley, are now refinancing their adjustable-rate mortgages and converting to traditional fixed ones before their payments jump.

The Gotways had an initial interest rate of 5 percent when they purchased last summer, but they noticed that it would soon start adjusting.

"We saw rates were going up and what that would do to our payment," Mary said. "We decided we needed to do something fast."

The couple refinanced to a 30-year, fixed-rate mortgage with an interest rate slightly below 7 percent. Their payment will climb a few hundred dollars a month with the new loan, but it would have jumped almost twice that much in the next few years under the terms of their ARM.

Some people don't pay as much attention to their loan documents and don't even realize how much their payments will climb until they get their mortgage statement.

Then, they are stuck making the higher payments until they can refinance. Some in subprime loans don't have high enough credit scores to refinance to a lower rate mortgage, so they are stuck.

"Many people out there with adjustable-rate mortgages don't have any idea when their rates will go up," said Terry Turk, president of Sun American Mortgage. "Those are the people who are going to get hurt."

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Falling behind

The number of people making late payments on ARMs in Arizona climbed during the second half of 2005.

At the end of the year, almost 10,000 homeowners across the state were behind on their payments for adjustable mortgages. That is almost double the rate from last summer, according to the Mortgage Bankers Association of America.

It's easy to see how people fall behind.

Rates on one-year, adjustable-rate mortgages are hovering around 5.7 percent, almost a percentage point less than a 30-year fixed mortgage, which hit 6.59 percent Thursday, the highest level since June 2002.

But the interest rate on a one-year ARM can go up as much as 2 percentage points a year. So someone who takes out one of those mortgages today could see his or her mortgage rate hit 7.8 percent next spring, which would erase all the savings of the past year.

The monthly payment on a $200,000 mortgage would climb from $1,167 to $1,432 with that rate jump.

"Teaser rates are very misleading," said Jay Butler, director of the Arizona Real Estate Center at Arizona State University Polytechnic. "People hear that they can get a 4 percent rate, which allows them to afford a home. But then they stop listening."

A Federal Reserve study this year found that 41 percent of homeowners with adjustable loans didn't have any idea about the maximum interest rate they could be charged.

About 17 percent of those homeowners polled didn't know how often their payments could change with an ARM.

Federal banking regulators want to make lenders better educate borrowers on adjustable-rate loans and their ability to afford one.

Joann Hauger of Community Housing Resources of Arizona said that the problem for people with ARMs is just beginning and that housing groups like hers are expecting to get many calls for help in three to four months.

Making matters worse for those homeowners who can't make higher ARM payments or refinance fast enough is a slowing real estate market.

Now, it's more difficult to sell a home quickly or make enough off a sale to pay off a home than it was during last year's housing-appreciation frenzy.

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Foreclosures follow

Last year, strapped homeowners were able to sell quickly for hefty profits or refinance into ARMs with artificially low teaser rates. As a result, foreclosures were at nearly record lows.

But now, a growing number of people are so stretched they are spending more than they earn.

First American Real Estate estimates that $297 billion worth of adjustable-rate mortgages issued nationally in 2005 and 2004 could end up in foreclosure.

Overall, U.S. mortgage delinquencies rose to 4.7 percent at the end of 2005, their highest level since mid-2004.

Arizona's delinquency rate was 3 percent at the end of last year, low by national standards and the 3.7 percent state rate from 2004. People falling behind on their mortgage due to the devastation of Hurricane Katrina pushed up the national delinquency rate.

The Valley's hot housing market in 2005 helped pull down the local rate.

But foreclosures in metropolitan Phoenix are already beginning to climb.

"If interest rates continue to go up and housing prices don't, more people will be squeezed," said Elliott Pollack, an Arizona economist and real estate investor.

"When the next recession rolls around, many people are going to be set up for a very bad situation."