Estimating Your ARM Payments
This calculator can be used to project or estimate the monthly payments, and potential interest rates associated with an adjustable-rate mortgage. The calculator needs a total of seven inputs, including:
- The value of the adjustable-rate mortgage, this is the total of all money borrowed
- The initial annual interest rate of the loan, which is different than the loan’s APR since it contains other expenses associated with writing the loan
- The term of the loan, stated in years. This is the time over which the loan will be repaid
- The fixed rate period, stated in years, which is the number of years before the initial interest rate can be adjusted
- The adjustment period, stated in months, which is the minimum number of months between any interest rate adjustment
- The potential adjustment each period. This is amount by which the interest rate is increased after each adjustment period has passed
- Finally, the interest rate cap, which is the highest allowable interest rate of the loan
The calculator then provides the user with six outputs, including:
- The initial monthly payment due on the ARM
- The maximum possible monthly payment
- The maximum possible interest rate, given the variable entered for the loan. Note this value will be equal to or less than the interest rate cap
- The total of all payments made by the borrower to the lender
- The total amount of finance charges, or interest, paid the lender
- Finally, a six-point chart showing the remaining balance of the loan over time
What is an Adjustable-Rate Mortgage, or ARM?
Also known as a floating rate mortgage, an adjustable-rate mortgage is a home loan that is structured with a variable rate. The initial interest rate is low relative to a more conventional mortgage and will remain at this level for a fixed period. After this initial fixed rate period expires, the interest rate can “adjust” no more than a predetermined rate. After each adjustment, the interest rate remains at this new level until the next adjustment period is reach. Each of these periods typically range from six to twelve months. In each subsequent adjustment period, the interest rate can once again change. This type of home loan will also be structured with an interest rate cap, which is the maximum interest rate charged over the term of the loan.
While most online ARM calculators will model the adjustment percentage per year as increases to the interest rate charged, the actual interest rate charged is typically indexed to a well-known standard such as the prime interest rate or the London Interbank Offered Rate, or LIBOR. For example, the lender might establish a fixed margin above the prime interest rate that will be used to determine the interest rate charged on the loan. If the prime interest rate is 5.000% and the margin is 1.5000%, then the interest rate on the ARM will continue to adjust until it reaches the interest rate cap or 6.500% in this example.
In the same way the prime interest rate can increase over time, it can also decrease. This is true of the interest rate target of the ARM too. For example, if during a subsequent adjustment period the prime interest rate decreases by 0.500% so might the interest rate on the ARM. The point being the interest rate charged can go up or down over time.
Common ARM Offerings
When ARMs are advertised by lenders, they’re usually reported as numerical pairs with the first number representing the fixed rate period and the second number representing the adjustment period. This second value is normally a one or a six with the one referring to one year and the six referring to six months. The most common combinations of these loans include:
- 5/1: this loan has a fixed rate for five years and an annual adjustment period thereafter
- 10/1: this loan has a fixed rate for ten years and an annual adjustment period thereafter
- 5/6: this loan has a fixed rate for five years and a six-month adjustment period thereafter
- 7/6 ARM: this loan has a fixed rate for seven years and a six-month adjustment period thereafter
- 10/6 ARM: this loan has a fixed rate for ten years and a six-month adjustment period thereafter
Modeling Adjustable-Rate Mortgages
Since future interest rates are not known, all ARM calculators take the same approach to modeling results, which is to present the user with a worst-case scenario. That is exactly how this calculator works too. Given the user’s inputs, the calculator assumes interest rates will rise over time but never exceed the interest rate cap. This means actual experience of the borrower could be less financially demanding than the maximum payment, maximum rate, total payments, and interest paid modeled by this tool.