Speaking broadly, a mortgage may be one of two types - a fixed rate mortgage or an adjustable rate mortgage (ARM). The word "rate" of course is referring to the loan's interest rate.

With a fixed rate mortgage, the interest rate does not change over the term of the loan. **But with an adjustable rate mortgage (sometimes called a variable rate mortgage) the interest rate is subject to change.** Twenty of thirty years ago, when interest rates were much higher AND trending down, ARMs were popular. People were taking out adjustable rate mortgages expecting that in two or so years, the interest rate would reset lower - thus saving interest charges.

Today, in a very low-interest-rate environment, ARMs have fallen out of favor. Nonetheless, some borrowers still want (or need due to lender requirements) adjustable rate loans. And some lenders issued loans fifteen or twenty years ago that are near maturity for which the borrower might require an audited statement.

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This example also applies to our online Ultimate Financial Calculator. The C-Value! program for Windows works similarly way and has a few more features.

All users should work through the first tutorial to understand basic concepts about the calculator.

## How to Calculate an Adjustable Rate Mortgage (ARM)

Tutorial 4

To create a loan schedule with an adjustable interest rate, follow these steps:

- Set "Schedule Type" to "
**Loan**"- Or click the [Clear] button to clear any previous entries.
- The top two rows of the grid will not be empty
- Delete the 2nd row by selecting it and clicking on the [Delete] button

- Set "Rounding" to "
**Adjust last interest**" by clicking on the {Settings} {Rounding Options} - In the header section, make the following settings:
- For "Calculate Method" select "
**Normal**". - Set "Initial Compounding" to "
**Monthly**". - Enter
**5.5**for the "Initial Interest Rate".

- For "Calculate Method" select "

- In row one of the cash flow input area, create a "Loan" series
- Set the "Date" to
**June 25** - Set the "Amount" to
**250,000.00** - Set the "# Periods" to
**1**- Note: Since there is one loan, you will not be able to set a frequency. (The calculator will clear it when you leave the row.)

- Set the "Date" to

- Move to the second row of the cash flow input area. Select "Payment" for the "Series" type.
**For this example, we will assume we want to create a schedule for a 15-year mortgage (180 monthly payments), which has a provision that the nominal annual interest rate can be adjusted every five years.**- Set the "Date" to
**July 25** - Set the "Amount" to "Unknown" by typing "
**U**". - Set the "# Periods" to
**180**. The result is a payment amount assuming a 15-year term using the initial 5.5% interest rate. - Use the [Tab] key to tab to Frequency. Select "
**Monthly**". - The "End Date" will automatically be calculated (June 25, 2034). 180 monthly periods is 15 years

- Set the "Date" to

- Your calculator should now look like this:

- Calculate the unknown. The result is $2,042.71

- Make the first interest rate change
- In row 2, change the "# Periods" of payments from 180 to
**60**. We have now set the calculator for five years of payments at an initial interest rate of 5.5%. - Move to the third row of the cash flow input area. Select "
**Rate Change**" for the "Series". - Set "Date" to
**June 25, 2024** - Enter "
**4.875**" for the new nominal annual interest rate. - You could change the compounding option by clicking on "Change Compounding" in the "Series Options" column, but we'll leave it set to "Daily"

- In row 2, change the "# Periods" of payments from 180 to

- Calculate the new payment. Move to the fourth row of the cash flow input area.
- Select "
**Payment**" for the "Series" - Set the "Date" to
**July 25, 2024** - Set the "Amount" to "
**Unknown**". - Set the "# Periods" to
**120**. We set this to 120 because after the 60 payments there are 120 remaining scheduled payments

- Select "

- Calculate the unknown. The result is $1,984.91. The new payment decreased due to the interest rate reduction.

- Prepare for the next rate change:
- In the 4th row, change the "# Periods" of payment from 120 to
**60** - Move to the 5th row. Select "
**Rate Change**" for the "Series" - Set the date to
**July 25, 2029** - Enter "
**5.75**" in the amount column for the new nominal annual interest rate

- In the 4th row, change the "# Periods" of payment from 120 to

- Click on the sixth row of the cash flow input area. Select "Payment" for the "Event" type.
- Set the "Date" to
**July 25, 2029** - Set the "Amount" to "
**Unknown**" - Set the "# Periods" to
**60**since after the previous 120 payments there are 60 remaining scheduled payments

- Set the "Date" to

- Calculate the unknown. The result is $2,027.40. The new payment amount increased due to the increase in the interest rate.

- If you want to see a detailed amortization schedule showing the monthly payment allocated between principal and interest, click on the "Schedule" button above the input area.

- Below shows the "Schedule" with one of the interest rate changes.

Summary: For adjustable rate mortgages & loans, the principal to follow is to calculate the payment amount for the number of ALL unknown remaining payments. After you have calculated the unknown payment amount, set the "# Periods" column to the number of payments the borrower will make at the new interest rate. Move to the next row and set up a new rate change. Then move to the next row and enter a new payment series with the amount unknown and the number of payments set to the total number of scheduled remaining payments. Again, calculate the unknown. Repeat until you have set up all payment series.

There are dozens of financial calculators on this web site. Some may be quicker to use, but except for the Ultimate Financial Calculator, none besides this adjustable rate mortgage calculator allow you to create an amortization schedule where the interest rate change can occur on a date other than a payment due date.

TValue is a trademmark of TimeValue Software.

## Lori Murray says:

how can I accrue interest so that after 3 months of missed payments – the principal is not added to and when payments resume – payments go to accrued interest?

## Karl says:

If you want to have the accrued interest added to the balance, enter a 0 payment row with the date you want the interest accrued through.

If the accrued interest is not being added to the balance, then set the loan to use "U.S. Rule." under "Calculate Method".