Can I Pay Off an Adjustable Rate Mortgage Early?

November 11, 1999, revised November 14, 2002, reviewed May 5, 2011

"I have been adding $100 a month to my mortgage payment every month because I was told that this would result in paying off the mortgage in 21 rather than 30 years. Last week, however, I was told that because I had an ARM, there was no way to pay off early. Is this true?"

It is difficult to pay off an ARM early, but doable if you know how. Your method of systematically adding a fixed amount to your payment every month won't reduce the term by more than a few months.

The reason is that every time the mortgage payment is recalculated to take account of interest rate changes, the calculation assumes that the loan will pay off in the period remaining of the original term. This means that your extra principal payments will reduce the monthly payment at the rate adjustment, with the new payment calculated to pay off over the original term.

For example, if your mortgage was originally for 30 years and 5 years have expired, the payment for year 6 would be calculated over 25 years. Hence, any additional principal payments you made during the first 5 years would result in a lower monthly payment, but no change in term. If you continue with the same extra payment of $100, you would not get any shortening of term until after the last rate adjustment, which on a one-year ARM would occur after 29 years. Shortening the term from 360 to 357 months was not your objective.

This points up an important distinction between fixed-rate and adjustable-rate mortgages that borrowers ought to consider very carefully. When borrowers make fixed extra payments to principal on a fixed rate mortgage, they shorten the term but don't affect the payment. When they make fixed extra payments to principal on an ARM, they reduce the payment on rate adjustment dates, but don't change the term.

Of course, you can always shorten the term significantly on an ARM by making a lump sum payment equal to the remaining balance. But to shorten the term significantly using partial prepayments, you must increase the extra payment at every rate adjustment date so as to offset the decline in the scheduled payment resulting from your prior prepayments.

This is a pain, but I now have a calculator that eases the pain substantially. This is Extra Payments Required to Pay Off By a Certain Period. Using this calculator to help you shorten the term of an ARM is described in Using a Calculator to Prepay an ARM.

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