Understanding Adjustable Rate Mortgages (ARM)

The calculator on this page helps you understand what the worst case impact on your principal and interest payment can be based on an ARM’s adjustment period, initial interest rate, periodic rate cap, and lifetime rate cap. The chart below shows how your principal and interest payment can change over the life of your loan. Notice that your payments will be fixed for the first years of your loan but can suddenly change after your adjustment period. (learn more about ARMs)

An Adjustable Rate Mortgage (ARM) is a popular form of mortgage if you plan to buy a home and live in it for only a few years before selling the home again. Unlike fixed rate mortgages that have a constant interest rate over the loan’s entire life, an ARM’s interest rate fluctuates over time. Depending on the length of time you think you will stay in the home, you can choose between ARMs that have a fixed rate for as short as 1 year to as long as 10 years.

One of the main components of an ARM is its adjustment period, the duration of time where the ARM’s Initial Interest Rate is effective and does not vary. When you hear the term ‘5 Year ARM’, this means that the ARM has a 5 year adjustment period where the interest rate will remain unchanged. Because your interest rate does not change during the adjustment period, your monthly mortgage payment will not change either.

After your adjustment period is over, an ARM’s interest rate becomes adjustable and can change significantly depending on the Index that the ARM follows. These fluctuations can result in a much higher mortgage payment. To limit the fluctuation, ARMs have a Periodic Rate Cap that limits the amount that the interest rate can change per year. Similarly, ARM’s have a Lifetime Rate Cap that limits the maximum interest rate of the loan regardless of index fluctuations.

Choosing an Adjustable Rate Mortgage can be seen as a gamble because it can both benefit you as well as be dangerous to you. The benefit of an ARM to you is that the short term interest rate on an ARM is typically lower than the interest rate of a fixed rate mortgage. For example, If you plan on staying in a home for only 5 years, a ‘5 Year ARM’ is a good idea because its interest rate will be much lower than a 30 year fixed rate loan and will cost you less. The danger of an ARM, however, is that if your plans change and you have to stay in your home for more than 5 years, the ARM’s interest rate can suddenly change after the 5 year adjustment period, possibly making your monthly mortgage payment much higher and burdensome.

How Adjustable Rate Mortgages Work

Interview

Loan Details

Loan Amount:
$
Adjustment Period:

Initial Interest Rate:
		%
Periodic Rate Cap:
		%
Lifetime Rate Cap:
		%

THIS SUMMARY PROVIDES ESTIMATES ONLY . Before making any home or loan purchase decision, you should obtain the advice of a professional financial advisor who is aware of your individual circumstances. Please refer to the Terms Of Use for a complete description of the proper use of this information.

Understanding Your Results

Adjustable Rate Mortgage: The above graph shows the impact that the variables of an adjustable rate mortgage can have on your monthly mortgage payment (principal and interest) each year. The graph shows that you monthly mortgage payment is unchanged during the adjustment period. To demonstrate the worst case impact on your monthly mortgage payment , the graph shows how your mortgage payment will begin increasing , limited by the periodic rate cap, as the loan’s interest rate approaches the loan’s lifetime rate cap.

Interest: When holding your mouse on a column, ‘Interest’ shows you the maximum interest that you may be charged on your ARM for that year. After your ARM’s adjustment period is over, the interest rate of your loan becomes variable and your exact rate becomes dependent on the value of the Index that your ARM is tied to (typically the LIBOR or the 1 Year Treasury Bill) plus the Margin (the percentage above the index value) that your lender charges.

The maximum interest rate that you can be charged on your ARM, will always be limited by your periodic and lifetime rate cap. If the value of the Index that your loan is tied to plus margin is above your lifetime rate cap, your loan interest rate will increase yearly by your periodic rate cap, until it hits your lifetime rate cap. The above chart demonstrates the maximum interest allowed by your loan for a specific year by assuming that your Index Value plus margin will always be higher than your lifetime rate cap.

Monthly Mortgage: When holding your mouse on a column, ‘Monthly Mortgage’ shows what your mortgage will be for that year assuming your interest rate adjusts to the maximum allowed by your loan for that year (based on your periodic and lifetime rate cap).