The index you list (3.5%) was probably the value of the index at the time you took the loan. You’ll need to know what index it refers to (e.g. LIBOR or Treasury). But regardless, a margin of 5.5% is fairly large. Consider most prime and Alt-A loans typically had margins of 2.25% to 2.5% above LIBOR or treasuries.
A 5.5% margin is not good. Your loan will likely reset at 8-10% or more. But make sure you know your terms in detail before doing anything.
seattle-relo gives good advice regarding recourse.
You are coreect that ultimately you are in a bind. Do not refinance if you think there is a possibility you will have to walk away (likely).
If I were you, I’d plan on living there until reset time, while keeping my eye on government bailout options. On the bright side, if in the unlikely event your income continues to grow at the same rate (10-20% per year) as it has the past 3 years, who knows, you may find yourself in a position to eat the higher payment and bail yourself out (depending on where prices settle).
