Q: My ARM just came up for an interest rate adjustment. How can I check my lender's calculation?
A: Calculating your ARM's new interest rate isn't that difficult, but it can be confusing.
There are a variety of indexes which can be utilized, a number of ways of calculating and rounding of the interest rate and the effect of any limits on the rate change which come into play. Some common ARM indexes have daily, weekly, monthly and even "moving" calculated values.
Having the precise information for your loan is key. In the paperwork you signed when you got your mortgage, you should find a mortgage note and/or an Adjustable Rate rider. In one of them, the specific name of the index will be noted, as will the scheduled date of change for your rate, and importantly, the period of time before the rate change which will determine the index value used to change your rate.
For example, your rate may be scheduled to change on June 1. The contract specifies the name of the index and that a value of 45 days prior to June 1 will be used to set the rate (the advance period is to provide sufficient time to notify you of an impending rate change).
To this value, a "margin" is added, often 225 to 275 basis points. The sum of the value of the index plus the margin becomes your new interest rate...sort of. Usually, the sum of the two will be rounded to the nearest one-eighth or even one-quarter percentage point, and this will become your new rate... sort of.
The “sort of” in this case comes in to play depending upon any interest rate limits which may apply. A variety of "cap" structures are used for ARMs, but after any initial change, most have annual change limits of upward or downward by no more than two percentage points from whatever your rate was last year.
To do your calculation and check your lender's work, you should first read your mortgage contract; once you know the specifics of your loan, you can check index values at HSH.com-- and if you know your remaining loan balance, you can even calculate your payment for the next change with HSH.com’s amortization calculator.
For more detail about reviewing your ARM's contract, you should check out our do-it-yourself guide.
A 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.