11/27/2007
How do I calculate the new rate on my Adjustable Rate Morgage (ARM)? THis is a great questions. If we've learned anything since the credit crisis and mortgage meltdown (not just subprime) is that our customers (most of them anyway) don't truly understand how their mortgage works and is affected by "interest rates." If they are in a "fixed" interest rate make sure they understand the difference between 30 year fixed, and a 30 year loan with shorter "fixed" period, like 3 or 5 years? You'd expect the answer to be obvious but it isn't. The use of the word fixed is extremely confusing for those that don't know that it can be applied to both an adjustable rate mortgage, and a regular 30 year fixed loan. There are a few bad apples in the bunch, and some mortgage brokers truly sold one product but gave them another. For the most part I believe that brokers sell the correct product, and explain the product, but there is a communication breakdown ( I love Led Zeppelin too).
Ok, Ok, so answer the question already.....
At the top of the Note it will tell you in big bold letters what kind of loan it is "Adjustable Rate Mortgage." Then read the headings of the different paragraphs contained in the note. One of the headings will tell you how to calculate the first interest rate change, and when it will happen. It will also tell you how to calculate future changes and when they will happen. It gives you the formula which isn't really that hard to figure out, the only unknown variable in the formula is what Index your mortgage is tied to. Most are tied to the 1yr LIBOR or 10 year Treasure. It will tell you in the note which one it is tied to. You can find the price or value of your index on the internet or in the Wall Street Journal in the "Money and Investing" section. Look for the "Borrowing Benchmarks" heading usually a few pages deep, then find your index. The LIBOR is "London Interbank Offered Rate, not "Libor Swaps". Some loans are based off the "One Month LIBOR", others off the "Six Month," but most are based off the "One Year LIBOR." This is the starting point for your formula. Add the margin that is stated in your Note. Typically this will be your new rate. However, there are limitations on the first rate change, each individual rate change, and the rate change over the life of the loan. These are called "caps" Sometimes the limit on the first adjustment is 2%. So Add the Index plus margin. If it is above %2 higher than your current rate then your new adjustment will be the maximum of %2 higher than your original rate. If the cap is %5 and the index plus the margin is less than %5 higher than your original rate than the Index plus the margin is your new rate. Example: 4.4 (LIBOR INDEX) + 2.5% (MARGIN) = 6.9% If your original rate was 4.5% then your new rate is the maximum cap of 2% change, so your new rate is 6.5%, not 6.9%. However if this is the case you can be assured that at the next change date your rate will go up again. Other Example: 4.4 (LIBOR INDEX) + 2.5% (MARGIN) = 6.9%. If the cap on the first change date is %5 and your original rate was 4.5% then 6.9% is within 5% of the original rate and the full index plus margin will be your new rate.
I will Blog more about this in the coming days to help clear up any misunderstandings.
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