Rationale For ARM Tables

 
These tables are for borrowers considering whether or not to take an adjustable-rate mortgage (ARM) rather than a fixed-rate mortgage (FRM); and if so, which of the many available ARMs to take. 

ARMs have the advantage of carrying a lower interest rate, and lower monthly payment, in the early years than fixed-rate mortgages (FRMs). But because the ARM rate is adjustable, it may rise in later years, and the payment will rise with it. Intelligent decisions about ARMs, therefore, require that account be taken of what might happen when the initial rate period ends. 

While future interest rates are not known, we can make assumptions about what will happen to rates; these are called interest rate scenarios. Usually, we focus on rising rate scenarios, because those are the ones we worry about.

For any given scenario, we can calculate exactly how high the rate and mortgage payment will go, and when it will get there. This is scenario analysis. We can also calculate the total cost over any period specified by the borrower. In  assessing ARMs with an IO option, borrowers will want to compare scenarios with and without the option.

When ARM rates are much lower than FRM rates, shrewd borrowers may take an ARM but make the payment that they would have had to make had they taken an FRM. By paying the balance down faster, the cost imposed by rising rates in the future is reduced. Hence, it is useful to perform scenario analysis based on the assumption that the borrower pays at the FRM rate for as long as that payment is larger than the ARM payment. 

This is an alternative to an IO, and based on the opposite premise. Where an IO attempts to minimize the borrowers payments in the early years, because the borrower has better things to do with his money, the FRM payment option is designed to pay down the balance as much as possible in the early years.

What the ARM Tables Contain

The ARM Tables show, for each of 5 ARMs and 5 different interest rate scenarios:

• Changes in interest rate and mortgage payment over the term of the loan. 

• Total cost over three periods specified by the user. 

The user can also specify that an ARM be interest-only for some period, or that the borrower makes the payment on an FRM so long as it is higher than the ARM payment. 

To see a sample of rates/payments and costs on an ARM, with and without both the interest-only and FRM payment options, click on  Sample Rates/Payments and Costs.

Procedure

1. Have your loan officer or mortgage broker provide the essential data on the features of each loan you are considering. To make it as easy as possible for them, print out and give them Worksheet of ARM Features.

2. When you have the worksheet filled out, click on ARM Tables Calculator, transfer the information from the worksheet to the calculator. The calculator will generate your tables.