Adjustable-rate mortgage (ARM) loans offer an alternative to fixed-rate loans for home buyers. These loans are attractive to home buyers as they offer lower interest rates during their initial period, which then adjust with market conditions after the initial period expires. Home buyers who choose this option are usually betting that interest rates will go down over the life of their loan, resulting in more savings. Part of determining your monthly payments with an ARM loan will involve calculating how the annual percentage rate (APR) will affect your loan. The Home Loan Expert is here to break down how to obtain this figure and the importance of understanding its overall impact on your ARM loan.
What is an APR?
Most homeowners are aware of the interest rate that is included on a mortgage loan, but this measurement does not provide them with a full picture that illuminates the true cost of borrowing. The annual percentage rate, or APR, provides these details by encompassing other loan costs in addition to the interest rate like discount points, origination fees, and any other costs charged by the lender. As expected, with these additional factors taken into consideration, your APR will be calculated at a higher value than the interest rate.
How Does Knowing the APR Help Home Buyers Make a Decision?
Lenders are required to show home buyers both the interest rate and APR on a mortgage loan. Comparing the APR on a mortgage to its interest rate will show you everything you need to know about if a lender is compensating for lower interest rates with increased lending costs and fees. An APR is calculated with the presumption that the loan will be paid over the original term (typically 15 or 30 years). This measurement is important to keep in mind because it indicates the break-even point on your loan. Home buyers will want to be mindful of this benchmark as they may choose to refinance their loan into a rate or term that will put them into a better position financially.
How is APR Calculated on an ARM Loan?
The following inputs are used to calculate the APR on an ARM loan:
- Mortgage Amount. This figure represents the loan amount taken out for the house.
- Term in Years. This input will be the term of your loan, usually set at intervals of 15 or 30 years.
- Starting or Initial Interest Rate. This is the interest you pay as a homeowner during the agreed-upon initial period based on the index rate and margin.
- Index Rate. The index rate is the interest rate that is tied to a specific benchmark with rate changes based on the movement of the benchmark.
- Margin. This variable is expressed as a fixed percentage rate that is added to the index rate. When combined with the index rate, it is used to determine the fully indexed interest rate of an ARM.
After the initial period expires, adjustments go into effect, which will cause your monthly payments to increase or decrease in alignment with market activity. These variables are used to determine how these adjustments will affect your monthly payments:
- Months Before First Adjustment. This is the initial rate period when the interest rate is fixed. Once the initial period expires, your interest rate will be subjected to market fluctuations based on its fully indexed interest rate.
- Months Between Adjustments. This is the number of payment periods between potential adjustments to your interest rate. Once per year is the most common rate for this input.
- Maximum Adjustment. There is a cap on this value. It cannot exceed a certain percentage of your interest rate. Usually, it falls within a range of 2% to 5%.
Closing costs and fees are calculated that are generally rolled into your mortgage but will affect your monthly payments. This could include origination fees, discount points, and other fees totaling within a range of an additional $1,000 to $5,000 in expenses.
How Does Having a Fully Amortizing ARM Affect APR?
The most common type of ARM is a fully amortizing ARM. This 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. Amortization is expressed by writing out how long the rate is fixed for, and how often it will adjust for the remainder of the term. For example, a 7/1 ARM would be fixed for seven years and adjusted every one year from that point onward. As the interest rate on an ARM changes, the fully amortizing payment 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, figuring out how to calculate ARM loans can feel like nailing jello to a wall. An ARM loan calculator is a tool that can assist homeowners approximate 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, 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 nation’s 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, initial interest rate, and cost caps. An ARM loan payment calculator will take the following 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 measured by the initial annual interest rate for this mortgage. It does not include other expenses such as mortgage insurance, and the origination fee and or discount point(s) 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 that the interest rate is fixed. Also included are the months between adjustments, which are the number of payment periods between potential adjustments to your interest rate, commonly set at 12 months.
Something worth noting — usually the adjustment variables stipulate that your payment would change once per year at most. The expected adjustment is also taken into consideration by calculating the amount you believe that your mortgage’s interest rate will change. This amount will be added to or subtracted from your interest rate. Last, the interest rate cap — 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 calculated, 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 your monthly payments will look like over the term of the loan. This is particularly useful when determining how interest rate variance will affect your monthly payments once the initial period ends. As the fluctuation in interest rates is determined by the changes according to the index rate; margins remain constant. An ARM calculator can show homeowners how much their monthly payments will go up based on increasing index rates, or if 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 team is familiar with the ins and outs of a myriad of loan types, from fixed-rate mortgage loans to ARM mortgage loans and the refinance options that exist in between. Our team of professional, friendly lending experts is able to serve our clients well, with a customer-focused platform that can help you determine if an ARM loan is the best decision for you and your family financially. What began as a dream of one individual, has now expanded to encompass a nationwide effort to get homeowners the best deal possible on a home loan. We provide personalized, face-to-face customer service to ensure that our clients feel heard and seen.
An Adjustable Mortgage Rate Calculator provides hopeful home buyers with a starting point to calculate an estimate of how a floating interest rate will affect your monthly payments. Our lending experts are able to provide you with the human touch that will give you clearer insight as to whether or not ARM rates fit your budgeting needs according to your own unique financial location. Reach out to us today at 800-991-6494 to find out more about how an ARM can influence your ability to realize a fully amortized loan schedule.