Mortgage Calculators: Comparing FRMs and ARMs

August 17, 2000, Revised March 18, 2003, June 27, 2007, February 6, 2011

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, which are explained in Payment Calculators For Adjustable Rate Mortgages.

We call the time-adjusted measure used for the comparison " 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 Annual Percentage Rate (APR) Versus Interest Cost on a Mortgage.

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 ARM inputs for calculators 9a and 9b are the same as those in calculators 7b and 7c, which are described in Payment Calculators For Adjustable Rate Mortgages.

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