Adjustable Rate Mortgage Calculator Step By Step

Adjustable Rate Mortgage Calculator

About Adjustable Rate Mortgage Calculator

The formula for computing Adjustable Rate Mortgage is per the below steps:

Adjustable Rate Mortgage Calculator

[P x R x (1+R)^N]/[(1+R)^N-1]

P is the loan amount
R is the rate of interest per annum
N is the number of period or frequency wherein loan amount is to be paid

Mortgage Initial Payment with Fixed-Rate

Next, we need to determine the outstanding principal balance before the rate changes.

Mortgage subsequent payments

Wherein,

P is the loan amountR is the rate of interest per annumR’ is the rate applicable subsequently.N is the number of periods or frequency wherein the loan amount is to be paid.

This calculator embraces a variable rate mortgageVariable Rate MortgageVariable-rate mortgage refers to a mortgage loan with a variable interest rate. The interest rate positively correlates with the market interest rate or the underlying benchmark interest rate, such as the CIBC prime rate, LIBOR rate, or federal funds rate.read more versus only a fixed-rate mortgageFixed-rate MortgageA fixed-rate mortgage is a loan whose interest rate remains constant throughout the term, and most of the payment is towards the interest in the initial period, whereas, at the end of the term, the majority of the payment is towards the principal amount.read more. Banks generally offer these kinds of loans as the bank will not like to lock in a rate for an entire period of the loan, and if they do so, they will face interest rate risk. If the interest rate goes up in the future, the bank would still be charging less interest rate to its customers and hence will affect their revenue. Further, the cost of operating for the bank could go up, and if they have lent at a fixed rate, then that shall impact their margins and could eventually impact their revenue statement. Further, even customers prefer floating rates as, and when rates fall, they would be benefited by reduced installment amount and reduction in interest outgo. This calculator shall be used to calculate what would be the periodically new installment when there is a change in the rate of interest during the life of the loan.

How to Use the Adjustable Rate Mortgage Calculator?

Adjustable Rate Mortgage Calculator Example

Mr. Bean has taken a very short-term mortgage loan for five years, and the term is 3/1 ARM, which means that the rate of interest will remain fixed for three years and after that rate shall change for the remaining term annually. The initial interest rate was 6.75%. It will be reset by 0.10% on every reset date. Based on the given information, you must calculate the total mortgage installment amount at each reset date, assuming the initial loan amount was $100,000 and installments are paid monthly.

Beginning with the 1st step, one needs to enter the loan amount, which is the principal amount: Multiply the principal by a rate of interest fixed during the initial borrowing. We need to compound the same by rate until the loan period. We now need to discount the above result obtained in step 3 by the following: After entering the above formula in excel, we shall obtain installments periodically. In the initial period, banks would have offered the terms when the rate would change. Calculate the outstanding principal balance just before that rate change. Repeat steps from step 4 but this time with the new interest rate applicable and with an outstanding period. If there is another rate change, then step 6 and step 7 will be repeated until the last rate change is considered.

Solution:

As the first step, we will first calculate the monthly installments based on the initial loan amount.

The monthly interest rate will be 6.75% / 12, which is 0.56%, and the period will be five years x 12, which is 60 months.

= ($100,000 x 0.56% x (1 + 0.56%)^60) / ((1 + 0.56%)^60 – 1)= $1,968.35

Monthly Installments based on the initial loan amount are shown below:

Now the rate of interest changes to 6.75% + 0.10%, which is 6.85% at the end of 3 years, and now the remaining period will be (5 x 12) – (3 x 12), that is 60 – 36, which is 24 months. Now we need to find out the principal balance at the end of year three which can be calculated below:

The monthly interest rate will be 6.85% / 12, which is 0.57%, and the outstanding principal balance is 44,074.69.

At the end of 3 years

= ($44,074.69 x 0.57% x (1 + 0.57%)^24 ) / ((1 + 0.57%)^24 – 1)= $1,970.34

Now again rate will be changed at the end of the 4th year, which shall be 6.85% + 0.10%, which is 6.95%, and monthly it shall be 6.95% / 12, which is 0.58%, and the loan period outstanding would be ( 5 x 12 ) – ( 4 x 12 ) which is 60 – 48 which is 12 months. Now we shall find out the principal balance outstanding at the end of period 4 below:

At the end of 4 years

= ($22,789.69 x 0.58% x (1 + 0.58%)^12 ) / ((1 + 0.58%)^12 – 1)= $1,971.39

Conclusion

An adjustable-rate mortgage or ARM mortgage calculator could be a smart choice for those borrowers who are planning to repay the borrowing within a specific period or those who shall not be hurt financially when there is an adjustment in interest rate.