How does 5 year ARM work?

[bill123]

On a 5 year ARM, my understanding is you pay at the low rate for 5 years as if you were paying the mortgage over 30 years.

My question is, when the loan resets for year 6, are your payments recalculated based on the remaining balance of the mortgage? Does prepaying help lower your monthly payment when it resets?

So if I borrow $160K at 2.3%. If I pay additional each month and at year 5 I only owe $100K. When the rate resets will my new payment take into account that I prepaid a good chunk of the loan? Or will the payments still be based on the $160K?

thanks

[Goldy]

On a 5 year ARM, my understanding is you pay at the low rate for 5 years as if you were paying the mortgage over 30 years.

My question is, when the loan resets for year 6, are your payments recalculated based on the remaining balance of the mortgage? Does prepaying help lower your monthly payment when it resets?

So if I borrow $160K at 2.3%. If I pay additional each month and at year 5 I only owe $100K. When the rate resets will my new payment take into account that I prepaid a good chunk of the loan? Or will the payments still be based on the $160K?

thanks

Its good to check with your lender but in general they do not reset the balance. We just refied into a 5yr arm so in year 6 our interest rate will be calculated by adding the LIBOR rate with the margin rate which for us is .125%. If you wanted to have a loan that took into account the amount of money you already paid down you would need to refinance at the end of 5 years.

[greenskeeper]

ARMs don't work, get a fixed rate mortgage, rates will never be lower.

[dczech09]

Yeah, I would say that this question about how ARMs work is irrelevant.

You should NEVER get an ARM. That is how it works.

Especially with the interest rate environment today- rates are at an all time low, so they really do not have anywhere to go but up. Sure, you may get a low rate today, but the rates will adjust upwards and you will get locked into some higher rate eventually.

Stick with fixed rate conventionals only. Avoid ARMs like a supermodel avoids chocolate cake

[Goldy]

I disagree. I think ARM's work very well for some individuals who think they are going to be moving in the next 10 years. I calculated that my break even timeframe assuming that after 5 years my ARM went up to the max % is 10 years. So if I move out of my house within 10 years I saved more money than if I had signed up for a 30 fixed.

[dczech09]

I disagree. I think ARM's work very well for some individuals who think they are going to be moving in the next 10 years. I calculated that my break even timeframe assuming that after 5 years my ARM went up to the max % is 10 years. So if I move out of my house within 10 years I saved more money than if I had signed up for a 30 fixed.

How about you sign a 10 year fixed then? It is a lower rate than a 30, and it is locked in. Comparing your max rate in 5 years versus a 30 year fixed rate is an arbitrary comparison.

[disneysteve]

You should NEVER get an ARM.

Never say never. Here's an example when an ARM was a perfect choice.

My cousin retired and moved to Florida where he bought a brand new house. He wanted to pay cash but in order to do so, he needed to cash out investments to make up the difference between what his former home sold for and the price of the new home. He was all set to do that but his accountant ran the numbers and advised him not to as it would have significantly increased his tax burden for the year. Instead, he took out a 5-year ARM at a rock bottom rate, lower than anything else out there. He'll liquidate the investments gradually over the next couple of years to avoid shooting into another tax bracket and have the loan paid off long before the rate adjusts, thus saving himself a bundle in both mortgage interest and taxes.

How about you sign a 10 year fixed then?

Obviously, the payment on a 10-year fixed would have been way higher than on a 5-year ARM.

[bill123]

I think I will be in this house 3 years minimum, 8 years maximum (when my kids get out of high school).

But my question is, how the payment recalculated at the end of 5 years?

[Goldy]

After 5 years your interest rate will adjust to the market rate plus prime based on the amount of money borrowed when the loan was originated.

[jpg7n16]

But my question is, how the payment recalculated at the end of 5 years?

My understanding is that your payment is recalculated based on the remaining principal balance owed at time of rate adjustment.

[Petunia 100]

Its good to check with your lender but in general they do not reset the balance. We just refied into a 5yr arm so in year 6 our interest rate will be calculated by adding the LIBOR rate with the margin rate which for us is .125%. If you wanted to have a loan that took into account the amount of money you already paid down you would need to refinance at the end of 5 years.

Well, I have always read just the opposite, that your loan is recast over the remaining term, so that extra principal payments do indeed decrease your minimum amount due.

OP, ask your lender. It doesn't really matter what generally happens, it only matters what your particular note says.

I also think an ARM can make sense under the right circumstances. Those who took out ARMs 10 years ago have done very well.

[Goldy]

Well, I have always read just the opposite, that your loan is recast over the remaining term, so that extra principal payments do indeed decrease your minimum amount due.

OP, ask your lender. It doesn't really matter what generally happens, it only matters what your particular note says.

I also think an ARM can make sense under the right circumstances. Those who took out ARMs 10 years ago have done very well.

Oops, looks like you guys are right. Well thats even better!

[Kooshiball]

In my view, interest rate must go up dramatically in order for government to sell its own debt (Mortgage rate is deeply correlated to short term or long term treasury rate). If people understand current financial system, it is mathematically impossible to force interest rate lower forever in spite of Fed Chairman Ben Bernanke's action that keeps interest rate artificially low until end of 2014. Once Fed stops printing money for US government to buy its own debt, interest rate shoot up in parabolic.

Therefore, fixed rate mortgage is the safest and rate is low enough that I don't think we need to take extra risk by borrowing ARM for small reward. To me, risk of taking ARM is just too huge for this small reward due to above.

[jIM_Ohio]

My understanding is that your payment is recalculated based on the remaining principal balance owed at time of rate adjustment.

This is my understanding too.

Most ARMs I have heard about are interest only, so when the rate resets, it is based on unpaid balance.

ARMS make sense when you look at short term payoffs as Steve indicated. Another great example is if a person is within 3,5 or 7 years of paying off mortgage, refinacing to an ARM of same length will probably pay off house faster than keeping a fixed rate mortgage.