August 18, 2000, Reviewed February 13, 2011
Trying to pay off an ARM early is tricky. Systematically adding a fixed
amount to the payment every month doesn't work because when the interest
rate changes, the mortgage payment is recalculated so that the loan will
pay off in the period remaining of the original term. This means that
the extra principal payments that have been made have the effect of
reducing the monthly payment at the rate adjustment, rather than the
term. This problem is described in
Can I Pay Off an ARM Early?
The only way to shorten the term on an ARM is to increase the extra
payment at every rate adjustment date so as to offset the decline in the
scheduled payment resulting from prior prepayments. My calculator
Extra
Payments Required to Pay Off By a Certain Period can help you by showing
the new extra payment you must make after every rate adjustment.
Here is an example using a 30-year 3/3 ARM, meaning that the initial
rate runs for 3 years, and the rate is adjusted every 3 years
thereafter. This loan was originally for $150,000 at 7%, rising to 7.25%
at the first rate adjustment when the balance is $145,090.
The borrower decides after 3 years that she wants to pay off the loan in
another 15 years rather than 27 years as scheduled. In the calculator
she enters the current balance of $145,090, the new 7.25% rate, the
period remaining of the original term of 324, the desired payoff period
of 180, and the first extra payment to begin in month 1. The calculator
shows a new scheduled payment of $1021.72 and an extra payment required
to pay off in 180 months of $302.76. This payment holds for the ensuing
3 years, when the rate and payment are adjusted again.
The rate at the end of year 6 falls to 7.125% and the new balance is
$127,139. These are entered in the calculator along with the new period
remaining of the original term of 288 and the new desired payoff period
of 144. The calculator now shows a new scheduled payment of $922.60 and
an extra payment required to pay off in another 144 months of $393.36.
At each rate adjustment, unless there is a massive increase in the rate,
the scheduled payment will decline because of the earlier extra
payments, and the new required extra payment will increase. If the
borrower sticks to this procedure, the loan will pay off in the desired
180 month period.
