"The interest rate on their mortgage had risen to 9.5 percent, from 3.5 percent three years ago. They didn’t have the equity or good credit to qualify for refinancing at a lower rate.”This quote was from Ben's 'the housing bubble' blog this morning and it perfectly illustrates the misconception that I hear all the time: "my interest rate is adjusting soon, but can only go up or down by the 2 % cap." Sort of. Keep reading your promissory note!
The error in understanding is due to focusing on just one cap rate. But there are two. One cap rate is the maximum rate the loan can achieve, the ceiling--usually 5-6% over the start interest rate. The other cape rate centers on how much it can adjust each adjustment period, typically no more than 2% up or down. But here's the kicker: the 2% cap rate is triggered ONLY AFTER the 1st adjustment period. Thus, your interest rate can skyrocket at the first adjustment all the way to the maximum full interest rate cap (ceiling) on the note.
In the above scenario you can see the borrowers recently hit their 1st adjustment period and were shocked that the rate adjusted up to the full 9.5% ceiling, which was 6% over their initial starting interest rate.
Head up to the attic and find the box where your closing papers are and start reviewing your promissory notes so you can plan accordingly. Loan programs vary and the above scenario may or may not apply to your situation.