How to Calculate a 5/1 Arm Loan

A 5/1 adjustable rate mortgage -- ARM -- is a home loan with the interest rate fixed for the first five years, after which the rate adjusts each year. This mortgage types gives the homeowner a set payment for the first five years at a rate that will be lower than the current rate for 30-year fixed rate mortgages. After five years, the loan will perform like a one-year ARM.

Tools

• The best way to calculate mortgage payments is with a loan calculator. There are numerous mortgage calculators available online, including the one on the Bankrate.com website (see Resources). Another option is a loan calculator template for spreadsheet software like Microsoft Excel or the free OpenOffice Calc. The Vertex 42 website offers a free downloadable template for both brands of software (see Resources).

Fixed-Rate Period

• The first five years of a 5/1 ARM will function the same as a 30-year fixed rate mortgage. To calculate the monthly payment enter the loan amount, interest rate and term of 30 years into a mortgage calculator. The calculated payment will be the same for the first 60 payments. For example, in early November 2010, Wells Fargo bank was quoting a rate of 2.875 percent on a 5/1 ARM. For a $250,000 mortgage, the monthly payment would be $1,037.93.

ARM Period

• During the ARM period of the loan -- years 6 through 30 -- the rate and payment will be based on the index rate and margin stated in the mortgage contract. The reset rate of every adjustable rate mortgage is based on a specific rate index. Commonly used rate indexes are the one-year constant maturity Treasury -- the CMT, 11th District cost of funds index --the COFI, or the London interbank rate -- the LIBOR. The loan contract will stipulate a margin to be added to the index rate when the rate resets, typically 2 to 3 percent.

ARM Reset Calculation

• To calculate the new payment when an ARM loan has a rate reset you need the index rate and margin from the contract, the current loan balance and the number of years remaining on the term of the loan. For the example 5/1 ARM, use the CMT as the index rate and a margin of 2.25 percent. The loan calculator shows a loan balance of $222,260 after the first five years. In November, 2010, the one-year CMT was at 0.23 percent. If the ARM was resetting at this time, the new interest rate would be 2.47 percent. Using the loan calculator with the balance, a new rate and a term of 25 years provides a sixth-year payment of $993.74.

Considerations

• Each year during the ARM period the payment calculation requires the use of the remaining term and the current loan balance. The example loan uses the current value of the index rate to calculate a payment, but actual rate will be the index rate in effect at the time of reset. Most ARM loans have an annual interest rate cap, which is the maximum the rate can increase at any reset period. If the example loan has a 1 percent cap, the max the rate would be at the first reset would be 3.875 percent, resulting in a payment of $1,157.89.