Your ARM's New Interest Rate: How To Check Your Lender's Calculation

This publication, originally released as a 12-page booklet in the 1980s, helped to dispel the myths and the anxiety about errors in ARM rates. It has been revised and expanded many times since then. Copyright © HSH Associates. All rights reserved.

If you have an Adjustable Rate Mortgage (ARM), you've probably heard of incorrect calculations by lenders when it comes to changing the loan's interest rate. At one time, the problem was quite widespread; in 1989, for example, estimates were that 20% to 30% of the then-current ARM adjustments were incorrect, in favor of both lenders and borrowers. If you have an ARM -- whether it's a traditional ARM, or a hybrid ARM that will soon end its fixed-rate term -- you should take the time to understand how your loan works, so that you might catch any errors in rate adjustments that may occur.

So Why Do ARM Rate Change Errors Happen?

Introduced during the high-interest-rate days of the early 1980s, ARMs are still an evolving product, even though they've been around for more than 40 years. From time to time, new variations appear in the market while earlier versions fade into oblivion, to the point where even lenders can become confused about the features and functions of each.

The vast majority of mortgages today are no longer held by the lender who makes them; instead, loans are sold into the 'secondary market', which can be institutions like Fannie Mae, Freddie Mac, and even other lenders. They create Mortgage-Backed Securities (MBS) that are secured by large 'pools' of similar loans; MBS are then sold to investors. In short, the place you send your monthly payment may, or may not, own or manage the loan. Some lenders, especially smaller ones, like to keep ARMs on their books, and may do their own management ("servicing") of those loans. This also includes other variable-rate loans such as Home Equity Lines of Credit.

In the mortgage world, there are many overlapping laws and regulations, most designed to protect homebuyers and homeowner, but also those to protect lenders, too. Many are both confusing and subject to interpretation. In the case of ARMs, virtually all adjustment errors can be traced to using the wrong index, using the wrong index value, selecting the wrong anniversary date, confusion over exactly when a new index value becomes available, rounding errors and even simple arithmetic mistakes.

Important: The worksheet below will let you determine whether or not your new interest rate has been adjusted correctly, but you can not calculate your new monthly payment of principal and interest with it. Also, you cannot use an amortization calculator (or amortization table) intended solely for fixed-rate mortgages to create and track your payment changes, but you can use one calculator that allows for changing the term, balance, and interest rate at regular intervals to determine your approximate monthly principal and interest payment. Your total payment, of course, will also depend on any taxes and insurance premiums that may be included for escrow purposes.

Understanding Your ARM

With an Adjustable Rate Mortgage, your loan's interest rate (and therefore your mortgage payment) will change every so often. For many ARMs, both the rate and the monthly payment will change annually. Other standard adjustment periods are every six months, and every two, three, or five years. The rate on some common ARMs (including hybrid ARMs) is fixed for an initial period, typically from two years to as long as ten years, and then adjusted on a regular basis thereafter. There are also ARMs in which the payment is adjusted annually but the rate changes more frequently, typically monthly. Some of these types of ARMs can allow negative amortization to occur; that is, the loan balance may increase when the required monthly payment doesn't rise as fast as the rate. Many of these kinds of ARMs fell under the monikers of "OptionARM" or "PayOption ARM", but there were much earlier variants that also allowed for negative amortization, too.

Whatever the adjustment frequency, your lender (or servicer) will calculate the new rate and monthly payment periodically. (The 'servicer' is the company which collects your mortgage payments. It may not be the same company that made the loan to you, but we'll use the term 'lender' for convenience.) The lender is required to inform you of your new rate and payment, generally at least a month before they will take effect. Mistakes can and do happen, however, and this article is designed to help you find them if they have occurred.

When your ARM is due to adjust, the do-it-yourself "Rate Change Worksheet" will enable you double-check the lender's calculation. (Alternatively, you can use this worksheet to forecast your new rate in advance if the index value is available.) If there is an error in the lender's calculation, it could mean either significant savings or additional cost to you, because the effect will be cumulative, year after year. Again, an error could be in your favor or the lender's -- but either way, you need to bring any error to the lender's attention. After all, a mistake today in your favor could turn out to be in the lender's favor next time.

To check on your rate, you must know both how and when the rate is adjusted. For this, you'll need to refer to your mortgage contract, which outlines the crucial ingredients of checking your ARM adjustment. You'll need to identify the index to which your loan is tied. There are several similar-sounding, but different, indexes, and we'll get into which is which in a moment.

There is also the margin that is added to the index value, and one or more caps, or limits, on the interest rate. Your loan could have an initial (aka 'first-adjustment'), a periodic (or 'per-adjustment') and a lifetime interest rate cap (or ceiling). Your "Adjustable Rate Note" and/or the "Adjustable Rate Rider" will also tell you the Change Date, which is the actual date when the new rate and/or payment takes effect. Finally, you need to know the 'lookback' period; this is the number of days prior to the Change Date on which the 'current index value' will be selected. This is typically 45 days before the change date, but could be more or fewer.

The final element is the index value that is or was in effect as of the Change Date. Many common and even not-so-common indexes can be seen in our list of ARM index histories.

Identify the Elements

First, print out the Rate Change Worksheet below, and enter your current interest rate in Line 7 (refer to your mortgage statement if necessary). Keep the worksheet handy to enter the other elements as you determine them.

The information you will need is contained in the Note and/or the Adjustable Rate Rider, part of the paperwork you received from the lender; you might also be able to use the Early ARM Disclosure Statement you received when you applied. Locate the paragraph or section which deals with "Interest Rate and Monthly Payment Changes". This section lists the change date(s), the index, the calculation of changes, and the caps on interest rate changes. Note: if your ARM has payment caps, your Note or Rider will be slightly different from the one described here, but the information you need will be listed similarly.

Change Dates

This tells you how often your rate will be adjusted, as well as the date(s) on which your new rate goes into effect. Most ARMs are adjusted every twelve months, with one annual Change Date. Another variety is adjusted every six months, and will thus have two Change Dates per year. Yet another, such as a Hybrid ARM, may also be adjusted annually -- but the first adjustment is delayed for up to 36 months or more. Knowing the correct date(s) is crucial to determining the correct rate.

The Index

It's important to know the precise name of the index; the names may sound alike, but there is a considerable difference between different indexes. For example, the index commonly called the "One-Year Treasury Bill" is most likely a Treasury Security -- or, to use its full and proper name, the "yield on United States Treasury Securities adjusted to a constant maturity of 1 year." These are also called "Treasury Constant Maturities" or TCM, or alternatively CMT. Other TCMs (or CMTs) used as indexes come in maturities of 1, 2, 3, 5, 7, or 10 years. (When using Treasury Securities, the ARM's adjustment period is often the same as the security's 'constant maturity'.)

One of the most common calculation errors involve TCMs, because they have both a weekly and a monthly value, and the lender may use the wrong one. If your ARM is tied to a TCM, be sure to note whether it uses the weekly or monthly value.

There is also a commonly-used Treasury value which isn't an actual index value as released by the Federal Reserve, but is instead created by calculation. The most common of these "derived" indexes is called the "MTA" or "12-MAT", shorthand for "Moving Treasury Average" or "12 (month) Moving Average (of the) Treasury". In either case, the last twelve monthly values of the one-year Treasury Constant Maturity are added together, and the sum is then divided by 12. This derived figure is the index value which is used to govern your interest rate. As time rolls forward, a new number is produced each month.

Another popular index used is for many years was the London InterBank Offered Rate, known as LIBOR (pronounced "lye-bor"). We'll skip the long, technical explanation and just note that it's a lending rate for loans between banks, not unlike our own Federal Funds Rate, although there are some key differences.

LIBOR came in many flavors and calculations. The InterContinental Exchange (ICE, which took over for the British Bankers Association (BBA), the original creator and publisher) released a series of LIBOR values every business day, but most residential loans weren't directly tied to it. Most were more commonly tied to the LIBOR listed in the Wall Street Journal, which is the ICE daily LIBOR, with publication of the data a day delayed.

In the so-called housing "boom years" of the 2000s, many ARMs were tied to a monthly LIBOR released by Fannie Mae, which used BBA or WSJ as the source but was calculated differently. For a time, Freddie Mac had their own version, too. LIBOR came in a number of terms including one month, three months, six and twelve months. Of these, the monthly and 12-month LIBOR values were the most widely utilized.

Although once the most popular ARM Index, LIBOR has been phased out. A rate-setting scandal during the financial crisis led regulators to look for a replacement, and starting in 2021 most new ARMs will use the Secured Overnight Financing Rate (SOFR) as an index in place of LIBOR, at least for ARMs that eligible to are sold to Fannie Mae and Freddie Mac. Fannie and Freddie will buy ARMs that use a 30-day average of SOFR as a basis for changing interest rates.

As well, TCM-based ARMs are also being phased out by the GSEs, who will stop buying ARMs based on this index at the end of June 2021. Existing ARMs -- products already originated and tied to Treasuries -- will continue to be tied to Treasuries, as these indexes will of course continue to exist.

Although Fannie and Freddie will no longer buy them, individual lenders who make ARMs (but who don't intend to sell them to Fannie or Freddie) can continue to use Treasuries (or other suitable indexes) as a basis for the ARMs they make and hold.

LIBOR, however, stopped being published in its native form at the end of June 2023, and a replacement index for outstanding LIBOR-based ARMs was approved by regulators. It's name is a mouthful: the "Refinitiv USD IBOR Consumer Cash Fallback". Fannie Mae calls this replacement index "a spread-adjusted term SOFR administered by the CME Group Benchmark Administration, LTD. and published by Refinitiv Limited." Essentially, it is a "term" SOFR value with a built-in adjustment that is intended to closely mimic the original 1, 3, 6 and 12-month LIBOR values.

A lot of other financial figures could be used as indexes. Some past favorites include the National Average Mortgage Contract Interest Rate On The Purchase Of Previously-Occupied Single Family Homes; this was replaced by an index called the "MIRS-Transition Index") the Six-Month Treasury Bill (yes, a true Treasury Bill), the Eleventh District Cost of Funds (COFI), a Federal Cost of Funds (FedCoF), a proprietary Cost of Savings Index (COSI), or still others.

Knowing the true index name is essential to finding and using the correct index value. Enter your index's name on the Rate Change Worksheet.

Calculation of Changes

This section of your Note or Rider lists the amount of the margin, and will also explain that your new rate will be the sum of the margin plus the current index value. If, for example, your margin is expressed as "2.5 percentage points," you will add 2.5 to the index value. The margin may also be expressed in basis points, each of which is one one-hundredth of one percent; that is, 100 basis point equals one percentage point. The sum of the index plus margin is typically rounded to the nearest one-eighth of a percent. This result is then subject to any cap listed in the "Limits on Interest Rate Changes" paragraph.

Write the margin on Line 4 of the Rate Change Worksheet.

Limits on Interest Rate Changes

This spells out the maximum rate you will pay the first time your rate is adjusted (the "initial cap" is based on your loan's initial rate), and then the per-adjustment cap (also called the periodic cap) for every rate change after that. A typical adjustment cap is 2%, but yours might be lesser or greater. (Item: some older ARMs sometimes had no cap on the first rate adjustment.) Enter the appropriate cap on Line 8 of the worksheet. Unless your ARM is at least three years old, the odds are that the "lifetime cap", "ceiling" or "maximum interest rate" listed won't apply. If you think it might, enter it side-by-side with the per-adjustment cap. Note: in most cases, your caps will apply to both upward and downward moves in interest rates -- a point to keep in mind if your rate is slated to decline.

Get Down to Brass Tacks

Armed with the elements of your ARM's rate adjustment calculation, you are now ready to use the ARM Index Histories with the Rate Change Worksheet. First, you will need to refer to a multi-year calendar (Time and Date is helpful) so that you can pinpoint the precise date on which the lender selected the index value (the "index date"). Most Notes specify using "the most recent index figure available as of the date 45 days before each Change Date."

Using your Note's lead time (also called "lookback period"), count the number of days backward from your change date. Include every day, including weekends and holidays. For example, if your change date is July 1, and your Note specifies a 45-day lead time, your index date is May 17; if your change date is January 1, your index date is November 17. (Use a calendar; in some cases the index date will not be the 17th.) Circle the appropriate date, and note which day of the week it falls on. Enter this date on your Rate Change Worksheet.

Now refer to the history of your ARM's index. Note that all 'week ending' dates are Friday dates. It is quite likely that your index date will not be a Friday. Now, refer to the paragraph below that is specific for your index.

Treasury Bill (T-Bill)

There may still be a few ARMs out there which use the "auction average" of the three- or six-month Treasury bills, but ARMs made at different times actually used the secondary market version of a T-bill. Some lenders may use 'T-Bill' to refer to the index, but only your Note knows for sure.

The method for looking up your 'T-Bill' index value is identical to that for Treasury securities, so refer to the method in the next paragraph. Please note that very few residential mortgage loan are actually tied to Treasury Bills.

Treasury Security, a.k.a. T-Sec, TCM, or CMT

The weekly values for Treasury Security indexes are released on Monday afternoon (around 4:30 PM Eastern time) for the week just ended. (Be sure to refer to the correct index: one, three or six months, or 1, 2, 3 years, etc).

If your index date falls on a Tuesday, Wednesday, Thursday, or Friday, use the value for the previous Friday's 'week ending' date. For example, an index date of Thursday, November 15 would refer to the weekly index value for the week ending Friday, November 9.

Index dates which fall on a Monday can be problematic. The problem was once so pronounced that it required 'official' clarification of the "most current available value" mess. A regulation dated December 1, 1991 from Fannie Mae and Freddie Mac attempted to take some of the guesswork out of those change dates. According to the regulation, the "most current available value" of a given index is as of the date of the release of the index from its respective source. Prior to the change, the most current value was interpreted as "the day following" the actual release. So, with the Monday release, the index value to use should be clear. Or is it?

So what if your index date falls on a Monday? Since the weekly index values are actually released on that day, the lender could theoretically use one of two available index values. A date of Monday, November 12 means that some lenders may be allowed to choose between the week ending either November 2 or November 9, depending upon what time of day they recast the rates in their portfolio. If you've received previous rate change notices, consult them for a clue. Enter the index value on Line 3 of the Rate Change Worksheet.

The monthly values for these indexes are generally available on the first Monday of the month around 2:30 PM Eastern time. Enter the index value on Line 3 of the Rate Change Worksheet.

Twelve Month Moving Average of the One-Year Treasury, Monthly Value (MTA, 12-MAT)

Since the MTA is just an average of the 12 most current monthly values of the One-Year TCM, the release date is the same as for the monthly TCMs -- the first Monday of the month. You can either do the match, or look it up here. Enter the index value on Line 3 of the Rate Change Worksheet.

National Average Mortgage Contract Interest Rate (NMCR)

This is a monthly index, available on or about the 24th of the month. Enter the index value on Line 3 of the Rate Change Worksheet. This index has been discontinued, but replaced for existing loans with the MIRS-TI index.

Eleventh District Cost of Funds (11COF)

This is a monthly index, and it's released on the last business day of the month for the previous month; i.e., a December 31 release will be for November's value. In most cases, your index value will be for the preceding month. Due to a declining number of savings institutions in the 11th district -- there were 200 in 1981 when COFI was developed, but only 9 now remain -- this index too was discontinued in early 2022. A synthetic replacement derived from the Federal Cost of Funds called the Enterprise 11th District COFI Replacement Index is to be used for existing loans tied to the old 11COF (like other replacement indexes, it is prohibited from being used on new ARMs). Enter the index value on Line 3 of the Rate Change Worksheet.

LIBOR

LIBOR is an acronym for 'London InterBank Offered Rate.' Without getting technical, it's the rate of interest at which banks borrow funds from other banks in the London interbank market. You can think of it as somewhat analogous to our own Federal Funds rate.

There are different 'flavors' of LIBOR, but in this context the variant produced by Fannie Mae was the most common for a long while, and may be the one you'll find as an ARM index for an older loan. More recent mortgages and jumbo ARMs and such will probably reference the LIBOR as posted in the Wall Street Journal. These LIBORs are available in one-, three-, six- and 12-month terms and is typically released on the second to last business day of each month.

As noted above, LIBOR was discontinued by its source on June 30, 2023. For outstanding ARMs, most lender will transition to using the value for the same term (1-, 3-, 6- or 12-month) "Refinitiv USD IBOR Consumer Cash Fallback" -- but check any notices you've received from your lender to make certain of the name of the new index your ARM will be using.

Other Available Indexes

There are still other ARM indexes. If your index is not included here, please contact your lender, check current and historical values of ARM indexes or if it is an obscure index, you may be able to track down the index at the source named in your Note or Rider. As long as it's out of the lender's direct control, virtually any financial indicator can be an ARM index, and there have been many esoteric indexes used on ARMs over the years.

Finish the Worksheet

Now add the margin to the index value, and enter the sum accordingly on Line 5. Next, round it to the nearest one-eighth of a percent (if your contract calls for it; use the table below for reference) this will raise or lower the result by a small fraction. For example, if your sum comes to 4.390%, round it down to 4.375%. A sum of 4.985% would round up to 5.000%. Rounding your rate can be tricky, so be careful! You'll probably find it helpful to do this on a notepad. (Supplying all the possibilities of rounded rates would fill a book.) Enter the result on Line 6.

Last step: Add your adjustment cap (if any) to your present interest rate, and enter the result on Line 9. Now, compare that result with the rate you've calculated on Line 6. Step V asks you to enter the lower of Lines 6 and 9 (which takes care of any cap which may apply); yours is the lower rate.

If You Find an Error

If, after checking your calculation(s) against that of the lender, you feel that an error has been made, it is important that you notify your lender; you'll find the address and phone number on your mortgage statement. If you call the lender, you should follow up with a letter (include your account number) indicating that you would like the lender to double-check their rate adjustment. You could enclose a copy of your worksheet, or simply mention where you think the mistake has been made (the index, rounding, etc). Verifying the calculation will take a little while, but your lender will respond once it has been completed. If an error has in fact occurred, you will receive a revised notice, detailing the correct rate and payment.

If you've been overcharged on past payments, the lender will probably (depending on state law) give you the choice of having the overage credited as a prepayment to your mortgage, or receiving a check for the entire amount. However, if it develops that you underpaid the loan, the lender probably cannot bill you for the difference.

While it can be a little complicated, we at HSH have tried to make the process of checking your ARM's interest rate a simple, easy to understand, process. It will only take a few minutes -- yet it can be time well spent, especially if it results in a savings to you.

Should You Refinance?

You may discover that, even with the correct interest rate, your ARM is currently more expensive than many fixed rate loans that are currently available in the open market. And, while some older ARMs featured a 'convert to fixed rate' feature, the conversion rate can often be significantly higher than the fixed rates currently offered by lenders on new loans.

One available option is to refinance your mortgage. Refinancing is not for everyone. Since it means getting a new mortgage, which can cost from several hundred to several thousand dollars in closing costs, you'll want to be reasonably sure that you'll keep the new loan long enough to recoup those expenses via the lower mortgage payment. HSH's "Should I refinance my mortgage? calculator" can help you decide.

Before you refinance, you'll again want to check your mortgage contract, this time for any "Prepayment Penalty" or "Early Termination" clauses. In the early years for many ARMs, you will be charged an 'exit fee' if you should decide to refinance (prepay) the loan. Some of these fees can be steep, perhaps 2% to 5% of the loan balance.

A fee charged in the case of a refinance may also be called a 'soft' prepayment penalty. So-called 'hard' prepayment fees will be charged not only if you refinance, but should you sell your home, as well. These fees will generally have a time limit before they expire, perhaps three years or so. Whether you should wait to refinance or not will depend upon the cost, your financial situation, and market conditions for interest rates.

Our helpful guide to refinancing your mortgage can help you determine whether you should or should not refinance, and HSH offers great tools and refinance calculators too.

---

RATE CHANGE WORKSHEET
HSH Associates ARM Check Kit ^sm