Mortgage Calculators: Comparing FRMs and ARMs
August 17, 2000, Revised March 18, 2003, June 27, 2007
Borrowers trying to decide whether they should select an adjustable-rate mortgage (ARM) or a fixed-rate mortgage (FRM) based on the lowest after-tax interest cost can now use calculators 9a and 9b.
Interest Cost Calculator, FRM Versus No-Negative Amortization ARM
Interest Cost Calculator, FRM Versus Negative Amortization ARM
These cover ARMs that don't allow negative amortization, and ARMs that do, respectively. They do not show mortgage payments. If you are concerned about whether or not you can deal with the mortgage payments on an ARM if interest rates increase, you should use calculator 7b or 7c.
We call the time-adjusted measure used for the comparison "mortgage interest cost." It is calculated in the same way as the APR except that the APR assumes that the loan runs to term for all borrowers, which makes it a treacherous guide. (See Does the APR Help?)
Interest cost is measured over the individual borrower's time horizon. Since most borrowers aren't exactly sure about how long they will be in their houses, we ask the user for their best guess, and also for the periods they view as the earliest and latest they might move. This allows the user to see whether and how differences in their length of tenure affect the cost comparison.
A second way in which interest cost differs from the APR is that interest cost may be measured after taxes at the individual borrower's own tax rate. The APR is always measured before taxes.
A third way in which interest cost differs from the APR is that the cost items included in interest cost may be more or less inclusive than those included in the APR. The APR is rife with inconsistencies and ambiguities with regard to exactly what is and what is not covered. Interest cost provides a list of cost items but the user can add or delete items as seems appropriate. For purposes of comparing two mortgages, cost items expressed as a percent of the loan amount that are identical for the two mortgages can be omitted because they will not affect the comparison. Cost items that are identical dollar amounts also can be omitted if the loan amounts are the same.
We ask for the down payment because mortgage insurance premiums are a cost item and premiums are higher on ARMs than on FRMs. If you make a down payment of 20% or more, no mortgage insurance is required. The other cost items should be self-explanatory.
The item "Most Recent Value of Interest Rate Index" requires you to identify the interest rate index that your particular ARM contract uses. The rate on every ARM is tied to movements in a specific interest rate series that is published periodically. About a dozen different series are used, and the one that applies to your ARM is shown in the ARM disclosure form that was given to you when you took out the loan. If you don't have it, call up the servicing agent to whom you send your payments and ask for the information. The table will provide the most recent value of the index automatically, but it may not be up to date. Current values are available at the following sites.
http://www.federalreserve.gov/releases/, http://www.hsh.com/indices/11cof00s.html, http://www.bankrate.com/brm/ratehm.asp, http://www.nfsn.com/library/mta.htm, http://www.mortgage-x.com/general/mortgage_indexes.asp, http://nt.mortgage101.com/partner-scripts/1196.asp?p=low-rate-mortgages.
The "Margin" is the amount that is added to the interest rate index to determine your ARM rate. It usually ranges from 2.5 to 3%. The margin that applies to your ARM is shown in the ARM disclosure form and on the mortgage note. If you can't find it, call up the servicing agent to whom you send your payments and ask for it.
The "Number of Months to First Adjustment" is the period for which the initial rate holds. The "Maximum Interest Rate Change on First Rate Adjustment" is the maximum amount by which the interest rate can change on the first rate adjustment date. ARMs on which the initial rate holds for 5 years or longer but which then adjust the rate every year are likely to have a larger cap at the first rate adjustment than on subsequent adjustments. Hence, provision is made in the calculator for two caps, one applicable to the first adjustment and the other applicable to all later adjustments.
For example, a new "7/1 ARM with caps of 5 and 2" is one where the initial rate holds for 7 years, the first rate adjustment cannot exceed 5%, rate adjustments thereafter occur every year and cannot exceed 2%. Hence, you would enter 84 and 5 under "First Rate Adjustment" and 12 and 2 under "Second Rate Adjustment".
The maximum and minimum interest rates apply over the entire life of the mortgage. They are in your note and ARM disclosure form.
You can select as many as 6 assumptions about future interest rates. You should always look at the Stable Index scenario as your benchmark, because it tells you what would happen if interest rates remain the same through the life of your loan. More precisely, it assumes stability in the specific index used by your ARM, but the interest rate indexes all tend more or less to move together.
The Worst Case scenario is also worth looking at because it is exactly what it says. This scenario assumes that rates increase by as much as the contract allows. If you can deal with the payment increases associated with this scenario, you are safe with this ARM.
Neither the no-change nor the worst-case scenarios are likely to materialize, so the calculator allows you to design other scenarios that you or your guru believe might be more likely. You can assume that the index rate trends either up or down by amounts selected by you, or fluctuates over periods and by amounts that are selected by you.
Borrowers trying to decide whether they should select an adjustable-rate mortgage (ARM) or a fixed-rate mortgage (FRM) based on the lowest after-tax interest cost can now use calculators 9a and 9b.
Interest Cost Calculator, FRM Versus No-Negative Amortization ARM
Interest Cost Calculator, FRM Versus Negative Amortization ARM
These cover ARMs that don't allow negative amortization, and ARMs that do, respectively. They do not show mortgage payments. If you are concerned about whether or not you can deal with the mortgage payments on an ARM if interest rates increase, you should use calculator 7b or 7c.
We call the time-adjusted measure used for the comparison "mortgage interest cost." It is calculated in the same way as the APR except that the APR assumes that the loan runs to term for all borrowers, which makes it a treacherous guide. (See Does the APR Help?)
Interest cost is measured over the individual borrower's time horizon. Since most borrowers aren't exactly sure about how long they will be in their houses, we ask the user for their best guess, and also for the periods they view as the earliest and latest they might move. This allows the user to see whether and how differences in their length of tenure affect the cost comparison.
A second way in which interest cost differs from the APR is that interest cost may be measured after taxes at the individual borrower's own tax rate. The APR is always measured before taxes.
A third way in which interest cost differs from the APR is that the cost items included in interest cost may be more or less inclusive than those included in the APR. The APR is rife with inconsistencies and ambiguities with regard to exactly what is and what is not covered. Interest cost provides a list of cost items but the user can add or delete items as seems appropriate. For purposes of comparing two mortgages, cost items expressed as a percent of the loan amount that are identical for the two mortgages can be omitted because they will not affect the comparison. Cost items that are identical dollar amounts also can be omitted if the loan amounts are the same.
We ask for the down payment because mortgage insurance premiums are a cost item and premiums are higher on ARMs than on FRMs. If you make a down payment of 20% or more, no mortgage insurance is required. The other cost items should be self-explanatory.
The item "Most Recent Value of Interest Rate Index" requires you to identify the interest rate index that your particular ARM contract uses. The rate on every ARM is tied to movements in a specific interest rate series that is published periodically. About a dozen different series are used, and the one that applies to your ARM is shown in the ARM disclosure form that was given to you when you took out the loan. If you don't have it, call up the servicing agent to whom you send your payments and ask for the information. The table will provide the most recent value of the index automatically, but it may not be up to date. Current values are available at the following sites.
http://www.federalreserve.gov/releases/, http://www.hsh.com/indices/11cof00s.html, http://www.bankrate.com/brm/ratehm.asp, http://www.nfsn.com/library/mta.htm, http://www.mortgage-x.com/general/mortgage_indexes.asp, http://nt.mortgage101.com/partner-scripts/1196.asp?p=low-rate-mortgages.
The "Margin" is the amount that is added to the interest rate index to determine your ARM rate. It usually ranges from 2.5 to 3%. The margin that applies to your ARM is shown in the ARM disclosure form and on the mortgage note. If you can't find it, call up the servicing agent to whom you send your payments and ask for it.
The "Number of Months to First Adjustment" is the period for which the initial rate holds. The "Maximum Interest Rate Change on First Rate Adjustment" is the maximum amount by which the interest rate can change on the first rate adjustment date. ARMs on which the initial rate holds for 5 years or longer but which then adjust the rate every year are likely to have a larger cap at the first rate adjustment than on subsequent adjustments. Hence, provision is made in the calculator for two caps, one applicable to the first adjustment and the other applicable to all later adjustments.
For example, a new "7/1 ARM with caps of 5 and 2" is one where the initial rate holds for 7 years, the first rate adjustment cannot exceed 5%, rate adjustments thereafter occur every year and cannot exceed 2%. Hence, you would enter 84 and 5 under "First Rate Adjustment" and 12 and 2 under "Second Rate Adjustment".
The maximum and minimum interest rates apply over the entire life of the mortgage. They are in your note and ARM disclosure form.
You can select as many as 6 assumptions about future interest rates. You should always look at the Stable Index scenario as your benchmark, because it tells you what would happen if interest rates remain the same through the life of your loan. More precisely, it assumes stability in the specific index used by your ARM, but the interest rate indexes all tend more or less to move together.
The Worst Case scenario is also worth looking at because it is exactly what it says. This scenario assumes that rates increase by as much as the contract allows. If you can deal with the payment increases associated with this scenario, you are safe with this ARM.
Neither the no-change nor the worst-case scenarios are likely to materialize, so the calculator allows you to design other scenarios that you or your guru believe might be more likely. You can assume that the index rate trends either up or down by amounts selected by you, or fluctuates over periods and by amounts that are selected by you.