We are reviewing our ARM disclosures and are using the "worst" case example. Our software does the calculations for the maximum payment in the example but I was asked if the maximum payment takes into consideration the payments that would have been made up until the point that it reaches the maximum rate? Is there a way to actually verify that? Thanks.

yes, but I will tell you from experience it probably doesn't, even if you have a promotional period. It also has a tendancy to put a very adverse rate on the TIL.

Not sure I understand?

Halito, if you want to verify, take your loan doc software and calculate a payment on $10,000 for 180 months (I'm using an example of 5 year ARM 180 month term) at say 7%. Payment should be around $89. Print the amortization schedule and take the balance shown for the end of year 5. Recalculate your payment based on that balance (around $7784), the maximum rate (we'll say 13%) and change the term from 180 to 120 (ten years left in the loan term). The payment will be around $116. Your payment example should coincide with those figures.

PS. Just understand that you have to take the balance at the end of the period where the loan will reach the maximum rate, and then adjust your remaining term from there. In the example I gave you the loan could have reached its maximum rate at the first rate change date. You also have to take into consideration the rate caps that may apply before the loan reaches its maximum interest rate.

How do you take the annual adjustments (i.e. 2%) into account? If we ran the 15-year historical example would it accomplish the same thing (as a way to "test")? I don't have access to the software and trying to get the person responsible for the software calculations and she is not sure how to do this.

Yes the historical example should take that into consideration, but how do you test if its correct if you're running it using the same software?

If you have caps, the process I described is a little more cumbersome.

But lets say you have a 2% cap per year and a 6% lifetime cap. Using a 1/1 ARM, it would be 3 years before the maximum rate would be reached. So you take the balance at the end of year one add 2% to the initial rate and calculate the payment out for the remaining term, at the end of year 2 you repeat the process and the same at the end of year 3. The payment you get at the end of year 3 should reflect your maximum payment.

PS. There are a couple of tools under the Reg. Z section of Banker Tools that may help you save some work.

Thank you, I used the 1/1 ARM example and this matched up my ARM example. I have a few more plans plus a few balloon plans. Just to be sure I understand, the payment example does not take into account the treasury index? What should I do differently for the balloon plan?

The payment example will take into consideration whether you have a discount/premium, rate caps, and if the maximum rate is based on the initial rate or the market rate. As an example if you have an ARM loan with a 1% discount, a 6% lifetime cap relative to the market rate then the rate can actually increase 7% from the initial rate. If the maximum rate is relative to the initial rate then 6% would be the maximum increase.

We don't offer variable rate balloons, but you would not do anything different for balloon loans, other than the amount of the balloon payment should also be disclosed in the payment example.