Mortgage acceleration works for adjustable rate mortgages (ARMs) in addition to fixed rate mortgages. Applying mortgage acceleration to an ARM produces very similar borrower benefits including reducing the required number of mortgage payments, significantly reducing total interest expense and shortening the term of the mortgage. Mortgage acceleration for ARMs is similar to acceleration for a fixed rate mortgage, except for one major difference. An ARM re-amortizes every time the mortgage rate adjusts and the monthly mortgage payment is recalculated at the time of adjustment.
For example, for a 10/1 ARM, the interest rate is fixed for the first ten years and then is subject to adjust once a year for years eleven through 30 of the mortgage. Because of the way amortization works for an ARM, your required monthly mortgage payment can potentially go down when you overpay your mortgage, even if your interest rate does not change when your mortgage adjusts (usually annually or semi-annually).
The potential for your required monthly mortgage payment to decrease when you apply acceleration to an ARM is a key difference as compared to applying acceleration to a fixed rate mortgage, where your required monthly mortgage payment does not change.
Below we provide examples that demonstrate how applying mortgage acceleration to an ARM enables you to lower your monthly mortgage payment in a steady interest rate environment or control your monthly mortgage payment in a rising interest rate environment.
In a steady or declining interest rate environment, ARM acceleration can produce very positive benefits by lowering your required monthly mortgage payment and reducing the term of your mortgage. This is in contrast to fixed rate mortgage acceleration, where you can only reduce your mortgage term but you required monthly payment remains constant over the course of the mortgage.
In the example below we compare a regular, non-accelerated ARM (blue line on chart) to an accelerated ARM (green line on chart). For the accelerated ARM, the borrower overpays his or her mortgage by $200 every month. Both mortgages in our example are $380,000 10/1 ARM mortgages with 30 year terms which means the interest rate is fixed for the first ten years and then subject to change annually (depending on fluctuations in interest rates) in years 11 – 30 of the mortgage.
The number of adjustment periods is important because an ARM re-amortizes every adjustment period, which results in a newly calculated mortgage payment. For our example the interest rates for the ARMs are held constant at 4.0% and do not change over the life of the loans. Although this is an unlikely scenario it makes comparing the two mortgages easier and better demonstrates the benefits of applying acceleration to an ARM.
The accelerated ARM results in a lowering the required monthly mortgage payment (red line on chart) by approximately $200 beginning in year eleven and greater interest savings as compared to the non-accelerated ARM. Using mortgage acceleration enables the borrower to reduce his or her required mortgage payment and save $29,340 in interest expense over the life of the mortgage.
Over paying an ARM during the fixed rate period reduces the required mortgage payment in the adjustable rate period
Lower monthly payment beginning in year 13 even with $200 monthly over payment$29,340 in Interest Expense Savings
Mortgage acceleration can also help you control your ARM monthly payment in a rising interest rate environment. By accelerating your ARM, you can help protect against a significant increase in your required monthly mortgage payment in the event interest rates rise during the ARM's adjustment period.
In the example below we use a $380,000 10/1 ARM with a 4.0% fixed period interest rate and compare a regular payment ARM with no monthly overpayment (third column in table) to an accelerated ARM (fourth column in table). In this example the interest rate increases to 9.0% at the beginning of year eleven. A 9% interest rate is likely a worst-case scenario but an interest rate increase of 5.0% is possible with many ARMs.
The borrower applies mortgage acceleration and overpays his or her mortgage by $200 every month during the initial ten year fixed rate period. Using mortgage acceleration enables the borrower to have a lower required monthly mortgage payment ($2,429 compared to $2,697) when the interest rate increases beginning in year eleven. Additionally, the mortgage balance at the beginning of year eleven for the accelerated ARM is almost $30,000 lower than the mortgage balance for the ARM with no mortgage acceleration. With the accelerated ARM, a lower mortgage balance means a lower mortgage payment and less total interest expense over the life of the mortgage.
Learn how mortgage acceleration works by watching our instructional video