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I am looking over some paperwork for a 5/1 ARM. The loan information is as follows:

Interest Rate: 2.75

  • Lifetime Cap: 5.00
  • First Adjustment Cap: 1.00
  • Annual Cap: 1.00
  • Margin: 1.75

I understand that my first 5 years would be predictable at 2.75% but what are some scenarios that could happen on my 6th year and so forth?

** NOTE: I understand that people are passionate about these subjects but this is a Q&A site. Specific Q's that need A's. Please make sure your A is answering my Q, please. **

  • Honestly I think you're best off first googling something like "understanding an ARM" and looking up the definition of these exact terms. I think you're asking someone else to analyze your mortgage for you, which is a pretty big task. I know that ARMs are highly dependent on the interest rates at the time at which it "unlocks" (at year 5). Because of that you are dealing with a lot more risk (your costs could go up greatly if interest rates went up to 5% or 10%) – CrimsonX Nov 9 '10 at 0:19
  • @CrimsonX - I'm pretty much looking for verification of the terms (which I already googled). Do you know the definition of the terms? Since I have a "first adjustment cap" of 1%, if rates went up 5% or 10% on my 6th year, my rate would only go from 2.75 to 3.75. Am I missing something? – Brian David Berman Nov 9 '10 at 2:07
  • I don't know them off the top of my head, sorry. You're right to double check your understanding if thats what you're looking to do. – CrimsonX Nov 9 '10 at 4:33
  • You asked "but what are some scenarios that could happen on my 6th year and so forth?". If you want more specific answers, include all of the relevant specific details in your question instead of chastising people who are trying to help you. – duffbeer703 Nov 14 '10 at 3:49
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I hope this image is clear. A spreadsheet is how I look at these things. Unfortunately, you didn't offer the starting balance so I use $100K which makes it easy to scale. You build a simple spreadsheet and enter the "what if" scenario, this tells me that worse case, an increase of 1% on the rate each year results in a near 60% increase in payments over the 10 years. Of course, this isn't the end of the story, I'd first change the payments to reflect the 5% rate, and see how much that drives the balance down. This would reduce the principal enough that the increase would be much less. On $100K, you'd pay $536.82 based on a 5% rate, regardless of the required payment. At 7.75% the payment is $563.11, not even 5% higher. If you'd like a spreadsheet started for you, I'll put it someplace for you to grab it.

spreadsheet

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    Brian, happy to do it. You'll see it in your email as well, but I linked above so anyone can grab it. I actually find the spreadsheets for stuff like this the very easiest way to look at an issue. You can create the worst case scenario, and while it can't (no one can) tell you the odds of rates going right up from here, at least you'll know where your payment can head. I have to add - this is for cash flow only, it doesn't take into account taxes, and the interest deduction. – JTP - Apologise to Monica Jan 10 '11 at 15:10
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You quote a rate (2.75%) and then quote a margin (1.75%). The margin is usually an addition to some base rate. How is the margin expressed in the figures you have? Is it included in the rate, or in addition to it?

As for the other stuff, it looks like the rate can go up at most 1% per year, up to a maximum of 5% increase. The first adjustment cap is also 1%. That just says that your first rate increase is capped the same as subsequent increases.

If the margin is already included, and the increases are based on your initial rate, then this puts you at a maximum of 7.75%.

You must verify this. I don't have your loan documents.

And again, why would you want to risk an increase at all? You have a decent fixed-rate mortgage already. That still doesn't make sense to me. Going from 2.75% to 7.75% as above can increase your monthly payment by over 40%.

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    The reason it makes sense is because it will take a "minimum" of 10 years (could even be longer) to reach 7.75%. 5 of those years I'll be guaranteed at 2.75%. 7 of those years I'll be guaranteed lower than my current 5% fixed rate. I plan to be out before the 5 years, but this gives me at least 7 years before I have anything over what I pay currently at 5%. – Brian David Berman Nov 9 '10 at 21:28
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Interest rates are at a record low and the government is printing money. You can get a fixed rate loan at a rate equal to inflation in a healthy economy. Unless you know that you are moving in < 5 years, why would you expose yourself to interest rate risk when rates are about as close to zero as they can be?

If your thought with respect to mitigating interest rate risk is: "What's the big deal, I'll just refinance!", think again, because in a market where rates are climbing, you may not be able to affordably refinance at the LTV that you'll have in 5-7 years.

From 1974-1991, 30 year mortgages never fell below 9%, and were over 12% from 1979 to 1985. Think about what those kinds of rates -- which reduce a new homeowner's buying power by over 40%, would do to your homes value.

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If the base rate is USD LIBOR, you can compute this data directly on my website, which uses futures contracts and historical data to create interest rates scenarios for the calculations: http://www.mortgagecalculator3.com/

If your rate index is different, you can still create your own scenarios and check what would happen to your payments.

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