ARM comparisons when
maturity is 15 years.
A previous post compared benefits and risks of the 51 and
71 ARM when amortization occurs over a 30year period.
This post makes the same comparisons for two ARMs with a
15year maturity.
Question: Consider a 51 ARM with a 2.8 percent initial
interest rate and a 71 ARM with a 3.2 percent interest rate. Both ARMs have a 15year term. The loan amount is $500,000.
What are the initial
mortgage payments for the two ARMS?
What are the balances when the ARMs reset?
What are loan payments if the reset interest rate goes to
6.0 percentage points?
(These are the same questions that I posed in the previous
post. The only difference is the term
of the mortgages  30 years in the
previous post and 15 years in this post.)
Tabulations: The calculations are laid out in the table
below.
ARM Comparisons
15year Terms 

51 ARM

71 ARM

Diff.

% Diff


rate

0.028

0.032


period

180

180


PV

$500,000

$500,000


Payment when loan taken
out

($3,405)

($3,501)

$96

2.8%

FV of loan

($356,023)

($296,194)

($59,829)

16.8%

Payment at first reset

($3,953)

($3,892)

($60)

1.5%

The payment difference at time of mortgage origination is
trivial  $96 or $2.8%.
The reduction in loan balance is a lot more after 7 years
than after 5. Difference is nearly
$60,000 nearly 17 percent.
Mortgage payments are lower for the 71 ARM because the
reduction in loan balance is more after 7 years than after 5 years. The payment difference at time of first
payment reset is only around $60 per month.
Caveats: The interest rise scenarios presented here understate
the risk of ARMs because interest rate resets are annual and rate increases
could be very large. The difference is
even more pronounced for the 51 ARM because there will be payment adjustments
after years 5, 6, and 7. The payment
could go up each year subject to a cap in the contract.
Concluding Remark: Choosing a shorter maturity (15 years rather
than 30 years) can substantially reduce financial exposure for mortgage
borrowers who choose ARMS over fixed rate mortgages. The reduction in exposure to risk stemming
from resetting interest rates is especially pronounced for the 71 ARM.
I am very interested in 71 ARMS that have a 15year
term. This product by a bank in
Missouri appears interesting.
One other difference is that the ARM adjusts for the
remainder of the loan. I believe it is
78 rather than 71. (71 ARMS adjust
annually.)
The rules governing ARMS are really arcane. There are three main indices. Payment changes are capped both annually and
over the lifetime of the instrument.
There are a lot of details. I am continuing my work on the ARM primer.
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