What Is a Reset Rate?
A reset rate is a new interest rate that a borrower must pay on the principal of a variable rate loan when a scheduled reset date occurs. The lender will provide details on a loan’s reset terms and interest rate calculations in the borrower’s credit agreement.
Breaking Down Reset Rate
A reset rate can be associated with all types of variable rate loans. Many variable rate loans have interest rates that are reset on a specified schedule. This contrasts with other types of variable rate loans which have floating rate terms.
A lender can structure any type of variable rate loan with interest that resets on a specified schedule. However, most variable rate personal loans will have a floating rate that changes whenever the underlying indexed rate increases or decreases. Adjustable rate mortgage loans are one type of product that is commonly structured with a specified interest rate resetting schedule.
A reset rate is a new interest rate on the principal of a variable rate loan when there is a scheduled reset date.
Variable Rate Interest
Variable rate interest loans are a complex product that includes both an indexed rate and margin in the interest rate calculation. Lenders base the loan on a specified indexed rate which is usually the prime rate, LIBOR or a U.S. Treasury rate. In the underwriting process, a lender will assign a margin to borrowers seeking variable rate interest credit. The margin is based on a borrower’s credit profile. It will be higher for low credit quality borrowers and lower for high-quality borrowers. The borrower is then responsible for paying a fully indexed rate which includes the indexed rate plus the margin.
In most variable rate loans, the fully indexed rate will change whenever the underlying indexed rate increases or decreases. In a variable rate loan with scheduled reset dates, the rate will be reset based on the schedule detailed in the loan terms. Variable rate loans can be reset on various schedules, which may include monthly, quarterly, or annual reset dates. If a loan has a scheduled reset date, then the reset rate will be changed to the fully indexed rate on that date. A rate can increase or decrease based on the market rate. It may also remain the same.
Adjustable Rate Mortgage Loans
Adjustable rate mortgage loans are one of the most common lending products using a scheduled reset date. These loans offer borrowers both fixed rate and variable rate interest over the life of the loan.
Borrowers can identify an adjustable rate mortgage loan with a scheduled reset date by its name. For example, a 5/1 ARM loan would pay a fixed rate of interest for five years followed by a variable rate which resets each year. The borrower’s first reset date would occur at the end of the fifth year at which time the interest would be reset to the borrower’s fully indexed rate. The fully indexed rate would then be reset on a 12-month schedule for the remainder of the loan’s duration.