Friday, September 14, 2007

How To Calculate Your Adjustable Rate Mortgage (ARM) Reset

With the popularity of Adjustable Rate Mortgages (ARM’s) during the 2004-2005 real estate boom, many homeowners are now facing the possibility of have their mortgage payments increase substantially.  Mostly these are the homeowners who were counting on the values of real estate to continue the upward trend and had planned to refinance before the reset would take place.  However, with the softening of the real estate market, many times the homeowners now owe more than the home is worth, thus making a refinance all but impossible.  And to make matters worse, many don’t know how it is that their interest rate is calculated.  They undoubtedly are expecting it to go up, but because they have no idea of what it is going to be, they have a difficult time preparing for it.  If you are in this situation, this will help you get a better idea of what to expect when your interest rate resets.

There is no way to know exactly what your Adjustable Rate Mortgage Interest Rate is going to be on the day it is scheduled to reset, but it is possible to calculate what it would be if it were to reset today.  Because your interest rate is tied to an index that fluctuates you won’t know what it’s going to be until that specific day.  But being able to calculate it today can only help you get yourself prepared.  To figure it out, you’ll need four things.  The first item you’ll need is the interest rate index to which your ARM interest rate is tied.  These will have a name like LIBOR, COFI, Prime Rate, CMT, CODI, or MTA.  You can then go to a website such as to find its most recent value.  The last I checked on 9/10/07 most of them were between 4.2% –  5.5%.  The second piece to the puzzle is the margin.  The margin is the amount added to the index to determine your interest rate.  The third thing you’ll need is the adjustment cap, which is the amount that your interest rate adjustment is limited to at each reset.  And lastly, you’ll need to know the lifetime maximum rate.  Not all ARM’s have adjustment caps, but they all have lifetime maximum rates.

The way to figure out your new interest rate is to take the index, plus the margin, subject to the adjustment cap and lifetime maximum rate.  Here are a few examples:

1.        Current rate is 5%, index is 5.5%, margin is 2%, adjustment cap is 3%, and the lifetime maximum rate is 10%.  The new interest rate for this ARM would be 7.5%.  The adjustment cap and lifetime maximum rate would not come into play in this scenario.

2.       Current rate is 4%, index is 5%, margin is 3%, adjustment cap is 3%, and the lifetime maximum rate is 10%.  The new interest rate for this ARM would be 7%.  The adjustment cap would limit the adjustment amount to 3%.  Without the adjustment cap the interest rate would reset to 8%.

3.       Current rate is 5%, index is 5%, margin is 6%, there is no adjustment cap, and the lifetime maximum rate is 10%.  The new interest rate would be 10%.  In this scenario the lifetime maximum rate would come into play.  The rate would have been 11% with a higher lifetime maximum rate.

Hopefully this will help you homeowners who are facing the possibility of an adjustable interest rate adjustment in the near future prepare for what you will see in the envelope that comes from your mortgage company.

-Steve Nicks

[tags] Phoenix real estate, Desert Ridge real estate, ARM, Margin, Index [/tags]