What interest rate should I use when making the amortization schedule for the APR calculation for the early TIL disclosure?

If I have an ARM loan with the following characteristics:
Term: 360 months
Initial rate: 4.00%
First change: 36 months
Subsequent changes:12 months
Index:3.25%
Margin:1.75%
Change cap:2%
Lifetime cap:2%

The handwritten formulas at the end of Appendix J to Reg Z (http://www.fdic.gov/regulations/laws/rules/6500-3550.html#fdic6500appendixjtopart1026) are a bit much for me. We've played with APR Win and several tools we found online but they all want us to plug in some interest rate or other and we're just not sure which one they mean, for an ARM. Of course our system does this for us, we are just trying to verify it ourselves as a test.

Payments at 4.00% for 36 months, then
Payments at 5.00% (3.25% + 1.75%) for the remaining 324 month term

Since we cannot forecast the future, we can assume that nothing will change. Your loan is discounted, so you just bring it up the the index plus margin taking into consideration the annual caps (which do not affect your case).

The process for creating or verifying a discounted (such as this example) or premium ARM is explained in Official Interpretation #10, Section 1026.17(c)(4). The most difficult part, as Rocky explains, is to produce a payment schedule--the kind required by Section 1026.18(g), not 18(s). Use Excel to crunch the payment schedule, TOP, and FC. Then, verify the AF.

After you have the payment schedule and AF, you can use APRWIN to calculate the APR. APRWIN is an implementation of Appendix J, so you do not have to worry about the math.

You didn't mention mortgage insurance. If it's a factor, then you must add another layer to the payment schedule so the MI renewal premiums are part of the payments used to calculate the APR.

Ugh, I am having a heck of a time figuring out how to use APRWIN on an ARM loan. I am thinking our ARMS are pretty vanilla and yet I am getting heavy duty violations. I thought I was calculating them correctly but I think I need some help to know if I am.

Here is the situation:
3/1 ARM with a discounted rate of 3.19% for the first 3 years.
2% cap per year
Margin is 2.875% and the index is 3.25% = fully indexed rate of 6.125%

Loan amount is $141,300 with a 30 year amort
There is no MI.

I come up with a payment stream of:
36 payments (3.19%) @ $610.30
12 Payments (5.19%) @ $760.76
312 Payments (6.125%) @ $834.85

When I enter that information in with what is the financed amount information and APR on the TIL I am way out of whack.

Am I totally messed up with my payment stream or am I missing something else here???? Thanks!

The pmts look OK with those IRs, but ARM notes generally call for rounding the adjusted rates to the nearest 1/8%. What does your note say?

The note mentions that it will take the index plus the margin and round to the nearest .125. So is my fully indexed rate wrong?

The fully-indexed rate is 6.125%, but the 1/8% nearest 5.19 is 5.25%. That's the rate you should use in your calculations of the payments and ending balances. Looks like the three payment streams should be $610.30, $765.53, and $834.87. See what that does to your APR calculation.

As a related issue, if your document generation system doesn't retain the amounts of the stepped payments, you lack sufficient information to satisfy Section 1026.25's requirement that you retain "evidence of compliance." Without those payment streams, your regulator will have the same problem you're experiencing.

This is what I am getting with your proposed payment stream

Our disclosed figures on the TIL
APR: 3.061%
Amount Financed: $140,902.95
Finance Charge: $74,472.17

APRWIN:
APR: 5.3780% (Understated by 2.3170%)
Finance Charge: $150,733.65 (understated by $76,261.48)

Your documentation system is clearly wrong. It produced an APR that's lower than any rate mentioned above. What did it use as the payment schedule?

The payment schedule on the note lists 36 consecutive payments of P/I beginning on April 1, 2014 and continuing on teh same day of the month thereafter. The payment will be in the amount of $610.30. Then 323 conseutive payments....

I thought that the APR could be lower if one was using a discounted rate as the initial rate?

It does seem like there is something amiss.

Now that I am looking at this I notice its a loan on bare land. But the other ones that involved dwellings I was trying to compute did the same thing. WOuld the bare land note have some bearing on this?

Based on this, it looks like maybe your documentation system didn't increase the rate a second time. Is the second payment stream all at the Initial rate plus 2%?

OK, so I was able to get the amortization schedule which has the first 3 years at 3.19% with payments of $610.31. Then the rest of the payments calculate out to 324 payments of $596.94 which is an interest rate of 3.00%?????? This cannot be correct is it? When I plug in that payment stream in APRWIN it comes out perfect.

Ok, i just realized that the fully indexed rate is .12 and the margin is 2.875 plus an 1/8th would be 3.0%. This is computing properly. Guess it pays to know what your index is. Thank you all so much for trying to help me. Looks like it was my mistake all along

With an initial rate of 5.19 and a fully indexed rate of 3.00 you have a premium priced ARM. This type of pricing can produce an APR that is lower than the note rate, but only if the PFCs don't kick the APR back up to the note rate or higher. PMI could also have that effect.

This was a good exercise. You now know how to take one of these things apart and assemble it blindfolded!

Thank you for the kind encouragement. I do feel I now have a pretty good grasp on how this stuff works...or at least how I can utilize the tools that are there for me. Thank you again for your willingness to help. Its good to know someone is here that really knows the ins and outs of this stuff.

Could I ask for some help now that you have this figured out? Please? I, too, am trying to calculate an ARM loan using APRWIN and am getting bad results.

ARM Term: 62 month / 12 month
30 year amortization
Index is .125 + 3.5% margin rounded to the nearest 1/8 of one percent: 3.625%
Each adjustment thereafter can increase or decrease by 2%
6% cap so the most the rate will ever be is 9.125%

Loan amortization in the file has payments of $207.96 for the entire 30 year term.

I am struggling and any help would be greatly appreciated!!

Just an observation. Balloon loans only service one purpose. They reduce interest rate risk. If you are going to offer ARMs, why in the world would you make them balloon loans. I think your bank needs to rethink their product mix.

You need to figure out the exact payment streams that your legal obligation will produce. It definitely is not 30 years of payments when it matures in 62 months.

It doesn't "mature" in 62 months. The first interest rate adjustment occurs in 62 months. Did my using the word "term" throw you off?

I am not sure if I am complicating things more than they have to be or not. I am trying to make sure I am using the correct payment streams on an ARM loan to verify my APRs. For instance, I have a loan with the following scenario:

Amount financed: $247,019.46
APR: 4.587%
Disclosed Finance Charge: $203,201.94
Loan date: 6-15-15 First Payment: 7-5-15

Amort. 30 years with 5yr initial hold then reviewing every 12 months thereafter.
The rate is 3.25 + 1.00 (margin) but the initial rate is 5.125%

I am using a payment stream of:
60 payments @ $1345.69
300 payments @ $1231.60

Could you tell me if I am doing this correctly or if my payment stream should be something different?

Step 1: review Section 1026.17(c)(1), OI #10; that is the official standard you must meet.
Step 2: read the portion of your ARM note (or rider) that spells out the formula for rate changes--including change and lifetime caps, rounding, and floor (if any.)
Step 3: generate the payment streams (P&I only) specified by OI #10.
Step 4: if the loan has MI, calculate the monthly renewal premiums up to the automatic termination date.
Step 5: layer the MI premiums (and any other type of FC that is collected periodically) over the payment streams you got in step 3.

This will give you the payment schedule Reg. Z requires you to use to determine the TOP, FC, and APR. Don't worry if the "new" rate & payment table shows something other than what you got in step 5. After verifying your disclosed TOP, FC, and APR, determine that the payment schedule from step 5 is being stored and retrievable in your retention files. Section 1026.25 requires you to maintain "evidence of compliance." Without the payment schedule from step 5, you have no evidence to support the disclosed TOP, FC, and APR.

Thank you for your response. I have read this section of the Reg until I am cross eyed and that is where I come up with the payment stream that I have listed above. My pessimistic side is still causing doubt in my mind that I have the stream correct. I guess the part that is puzzling to me is the second part of the stream. After the fixed portion, I interpret it to say that with out knowing the rate changes, I should show the remaining 300 payments based on the information that we know at this time. Is that correct or am I totally off base?

What does your note say about:
- rate change caps (regular and life-of-loan)?
- interest rate floor?

Although the rules for producing a TIL payment schedule are complex, they are logical. Section 1026.17(c)(1) tells us that all calculations and disclosures must be based on the terms of the legal obligation (note plus riders, modifications, and any other supplemental agreements). When the legal obligation doesn't or can't supply all the information necessary to produce the TIL payment schedule, you are required to estimate--using the best available information. In a typical ARM loan, the only unknown information is future index values. Since one guess at future interest rates is no better than another, Reg Z relieves you of the duty to concoct (and defend) a future rate scenario. OI #10 (mentioned above) tells you that you are to pretend that the most recent index value will never change. In your example, that would be a constant index of 3.25%.

The caps, floor, and ceiling in your note are known and relevant. As you construct the TIL payment schedule (a guesstimation based on OI #10), all interest rate changes (and corresponding payment changes) must reflect the caps, floor, and ceiling in your note. Since your example is a "premium rate" ARM (because the note rate (5.125%) exceeds the fully-indexed rate (4.25%)), then you might have a second payment stream to reflect the downward step in the rate/payment. Whether or not there will be a downward step depends on the presence or absence of a floor. If there is a floor and it equals the initial note rate, then no downward steps are possible and your TIL payment schedule willl have a single stream. If there is no floor, then downward steps (one or more) are possible, BUT each step must reflect the rate change caps in your note.

**BUMP**

Considering OI 10 (language below), is my thought process for a 7/1 ARM payment stream for APR purposes accurate:

If the initial/start rate is lower than the fully indexed rate, there would be two payment streams:
1 - 7 years at the initial/start rate
2 - 23 years at the fully indexed

When creditors use an initial interest rate that is not calculated using the index or formula for later rate adjustments, the disclosures should reflect a composite annual percentage rate based on the initial rate for as long as it is charged and, for the remainder of the term, the rate that would have been applied using the index or formula at the time of consummation. The rate at consummation need not be used if a contract provides for a delay in the implementation of changes in an index value. For example, if the contract specifies that rate changes are based on the index value in effect 45 days before the change date, creditors may use any index value in effect during the 45 day period before consummation in calculating a composite annual percentage rate.

If the initial/start rate is lower than the fully indexed rate, there would be two payment streams:
1 - 7 years at the initial/start rate
2 - 23 years at the fully indexed

I didn't go back and read previous posts but whether that statement is true would depend on the rate cap structure.

Years 1-7 would reflect the discounted rate.
Years 8-30 would reflect the fully indexed rate if the fully indexed rate can be reached in year 8.

Depending on your rate cap structure at each change date you could have multiple payment streams before the fully indexed rate is reached.