Overpaying, or accelerating, an adjustable rate mortgage (ARM) can lower your monthly payment but the specific answer to your question depends on where you are in the loan and how your mortgage rate changed.
In short, the monthly payment for an adjustable rate mortgage can only change when the mortgage rate adjusts. So if you overplay your loan during the initial fixed rate period of an ARM -- for example, in the first five years of a 5/1 ARM -- your required mortgage payment does not change.
When the loan adjusts, however, your new monthly mortgage payment is based on your current loan balance and interest rate, which is calculated according to your loan terms. If your mortgage balance has decreased because you overpaid your loan, then your monthly payment may also decrease, depending on if your interest rate increased, decreased or remained the same.
Review How Mortgage Acceleration Works for an Adjustable Rate Mortgage (ARM)
Returning to the above example, if you overpay your loan during the first five years of a 5/1 ARM, your required monthly payment may potentially go down when the loan adjusts for the first time at the beginning of year six. How much your payment changes, and in what direction, depends on your new interest rate, which is also called the fully indexed rate.
If your interest rate decreases or stays the same, then your required mortgage payment also decreases. If your rate increases, your payment may also increase depending on the magnitude of the increase and your loan balance. In either case, your required payment is lower than what it would be if you did not overpay your ARM during the fixed rate phase of the loan.
The same logic applies for the remainder of the mortgage. For example, for a 5/1 ARM, your rate and payment are fixed for the first five years but are subject to change usually every six months or a year for the remaining 25 years of the loan, which is also called the adjustable rate period.
If you overpay your loan during the adjustable rate period of an ARM -- for example, in year six of a 5/1 ARM -- then your required monthly mortgage payment could go down at the next adjustment period, depending on your new interest rate. Although your payment does not change in between adjustment periods, reducing your loan balance by overpaying your mortgage results in a lower payment or a smaller increase in your payment the next time your loan adjusts.
Simply put, with an ARM, the lower your mortgage balance, the lower your monthly payment when the loan adjusts, regardless of your new interest rate. This is why overpaying an ARM can save you money and help protect against payment shock if interest rates increase significantly.
Please note that overpaying your mortgage is only one of several factors that determines the monthly payment for an ARM. Because the mortgage rate for an ARM is subject to change, your monthly payment may not decrease as much as expected and can potentially go up if your interest rate increases, even if you accelerate your loan.
Overpaying an ARM, however, always reduces the length of your loan and saves you money in total interest expense as compared to not accelerating your mortgage.« Return to Q&A Home About the author