A borrower received a 30-year ARM mortgage loan for $120,000. Rate caps are 3/2/6 (first adjustment/subsequent adjustments/total over the life of the loan). The start rate was 3.50% and the loan adjusts every 12 months for the life of the mortgage. The index used for this mortgage is the LIBOR, which, for this exercise, let’s say was 3.00% at the start of the loan, 5.00% at the end of the first year, and 4.50% at the end of the second year. The margin on the loan is 3.00%, which remains the same for the duration of the loan.
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To calculate the adjusted interest rate for each year of the ARM mortgage loan, we need to follow these steps:
1. Calculate the fully indexed rate:
- Add the current index rate (LIBOR) to the margin rate.
- The fully indexed rate for the first year would be: 3.00% (LIBOR) + 3.00% (margin) = 6.00%.
2. Apply the rate caps:
- The rate caps determine how much the interest rate can increase or decrease in each adjustment period.
- The first rate cap (first adjustment) is 3%.
- Therefore, the adjusted rate for the first year cannot exceed 3% above the start rate. Since the fully indexed rate is 6.00% and the start rate is 3.50%, the adjusted rate for the first year is limited to 6.50%.
3. Calculate the new principal and interest payment:
- Use the adjusted rate to calculate the new monthly payment using the remaining loan balance.
- The borrower received a $120,000 loan, so let's assume a fixed monthly payment based on that amount for the entire loan term.
Let's calculate the adjusted principal and interest payment for the first three years:
Year 1:
- Start Rate: 3.50%
- Fully Indexed Rate: 6.00%
- Adjusted Rate (capped at 6.50%): 6.50%
- Monthly Payment (based on $120,000 loan amount): ?
Year 2:
- Start Rate: 6.50% (adjusted rate from Year 1)
- Fully Indexed Rate: 7.50% (3.50% start rate + 4.00% increase due to LIBOR increase)
- Adjusted Rate (capped at 9.50%): 9.50%
- Monthly Payment (based on remaining loan balance): ?
Year 3:
- Start Rate: 9.50% (adjusted rate from Year 2)
- Fully Indexed Rate: 8.50% (5.50% start rate + 3.00% increase due to LIBOR decrease)
- Adjusted Rate (capped at 12.50%): 12.50%
- Monthly Payment (based on remaining loan balance): ?
Please note that the loan balance is decreasing each year due to loan payments. Update the loan balance for each subsequent year to calculate the new monthly payment accurately.