Mortgage loans are typically issued in 15-year or 30-year terms. These loans also allow home buyers to choose between a fixed-rate mortgage or an adjustable-rate mortgage (ARM). With a fixed-rate mortgage, the interest rate remains at a constant fixed price over the life of the loan.
With an ARM loan, there is an agreed-upon interest rate during the initial term. But once the initial term comes to an end, the interest rate will adjust either monthly or yearly over the life of the loan. Home buyers who choose ARM loans over fixed-rate mortgages generally do so because they believe that mortgage rates will fall over the life of the loan—or because they plan to move out of the home before the fixed period ends.
What Does an Adjustable Mortgage Rate Look Like?
As mentioned above, ARM loans have an initial interest rate period which then switches to a floating interest rate once the initial period expires. There are several common ARM terms homeowners can choose from:
- 3/1 ARM. The initial period set for this interest rate is fixed for 3 years. Then, it adjusts annually for the remaining term of the loan.
- 5/1 ARM The initial period set for this interest rate is fixed for 5 years. Then, it adjusts annually for the remaining term of the loan.
- 7/1 ARM The initial period set for this interest rate is fixed for 7 years. Then, it adjusts annually for the remaining term of the loan.
- 10/1 ARM. The initial period set for this interest rate is fixed for 10 years. Then, it adjusts annually for the remaining term of the loan.
It’s also possible to see terms like a 2/28 ARM, which means the initial fixed-rate period lasts for 2 years with an adjustable rate lasting 28 years. Regardless of the ratio, the first number will always represent the initial fixed interest rate period, with the second number representing the adjustable interest rate that remains on the loan term.
The most common type of ARM is a fully amortizing ARM. This kind of ARM operates under the condition that a homeowner will have their loan fully paid off if every payment is made according to the original schedule on the loan term. And as the interest rate on the loan changes, the fully amortizing payment also changes. The term on an ARM loan typically lasts for 30 years.
What is an Adjustable Mortgage Rate Calculator?
Due to fluctuating interest rates that occur after the initial period on an ARM expires, calculating monthly payments can feel like nailing Jell-O to a wall. Using an ARM calculator can assist homeowners estimate possible adjustments to their mortgage payments.
There are two main inputs that influence the interest rate on an ARM: the indexed rate and the margin. The indexed rate is an interest rate that is tied to a specific benchmark, with rate changes based on the movement of the benchmark. The most common benchmarks for indexed interest rates include the prime rate, London Interbank Offered Rate (LIBOR), and U.S. Treasury securities. These interest rates usually move up and down in alignment with the general movement of interest rates in the economy. The margin is a fixed percentage rate that is added to an indexed rate. These two added variables determine the fully indexed interest rate of an adjustable-rate mortgage.
ARMs are composed of five primary components: the index, your lender’s margin, the calculated interest rate, the initial interest rate, and cost caps. ARM calculators take the all of these input variables into account when determining what your monthly payments will look like:
- The Mortgage Amount. This is the original or expected balance for your mortgage.
- The Initial Interest Rate. This is the initial annual interest rate for the mortgage. It does not include other expenses such as mortgage insurance, the origination fee, and/or discount points that are reflected in an APR (which is usually higher than the initial interest rate).
- The Term in Years. Loan terms (the years over which the loan gets paid off) are typically set at 15 or 30 years.
- The Adjustment Variables. This includes the number of months before the first adjustment. This variable indicates the number of months during which the interest rate will be fixed. Also included are the months between adjustments, which are the number of payment periods between potential adjustments to the interest rate (commonly set at 12 months). This means your payment would change once per year at most. Last, the interest rate cap, or the highest allowable interest rate for your mortgage, is calculated. This input is important because your interest rate will not be adjusted above this rate.
Once all of these inputs have been compiled, you will be able to look at a report indicating how your monthly payments are affected by an ARM loan.
How Does Using an Adjustable Mortgage Rate Calculator Help Home Buyers?
Using an adjustable mortgage rate calculator can help homeowners determine if an ARM loan is the right choice for them in several different ways. First, using an ARM calculator provides a clearer picture of what monthly payments will look like over the term of the loan. This is particularly useful when determining how interest rate variance will affect monthly payments once the initial period ends.
Fluctuation in interest rates is determined by the changes according to the index rate, but margins remain constant. An ARM calculator can show homeowners how much their monthly payments will go up based on increasing index rates. These calculators can also show whether the monthly mortgage rate will decrease or remain the same as index rates fall.
How Can The Home Loan Expert Help?
The Home Loan Expert is familiar with the ins and outs of all home loan types, from fixed-rate mortgage loans to ARM mortgage loans, as well as the refinance options that exist in-between. Our professional, friendly lending Experts can help you determine if an ARM loan is the best financial decision for you and your family. No matter what loan type you’re looking for, we’ll provide personalized, face-to-face customer service to ensure that you feel heard and seen.An Adjustable Mortgage Rate Calculator is a great tool for home buyers, providing a starting point to calculate an estimate of how a floating interest rate might affect your monthly payments. Reach out to us today at (866) 221-1926 to learn more about which inputs will affect your ARM loan. We are also available to chat online at any time.