How an Adjustable-Rate Mortgage Works
An adjustable-rate mortgage (ARM) has two distinct phases. During the initial fixed-rate period, your interest rate and repayment are locked in, just like a fixed-rate loan. Once this period ends, the rate resets based on a market reference rate plus a lender margin, and then continues to adjust at set intervals (for example, every 12 months) for the remainder of the term.
In New Zealand, the closest equivalent to an ARM is a floating-rate or revolving credit home loan, where the rate moves with the official cash rate (OCR) and can change at any time the lender chooses. Many NZ borrowers also roll short fixed-rate terms (for example, fixing for one or two years at a time), which produces a similar effect to a traditional ARM once each fixed term expires.
The Standard ARM Payment Formula
Each time the rate resets, your new monthly payment is recalculated on the outstanding loan balance with the new rate for the remaining term. The standard mortgage payment formula is:
P = L x [r(1+r)^n] / [(1+r)^n - 1]
Where P is the periodic payment, L is the outstanding loan balance at the reset date, r is the periodic interest rate (annual rate divided by the number of payments per year), and n is the number of remaining payments. This calculator applies this formula at each rate adjustment point.
Rate Caps Explained
| Cap Type | What It Limits | Typical Value |
|---|
| Initial adjustment cap | Rate change at the very first reset | 2% to 5% |
| Periodic adjustment cap | Rate change at each subsequent reset | 1% to 2% |
| Lifetime cap | Total increase above the initial rate, ever | 5% to 6% |
This calculator uses a single periodic cap (applied at every adjustment, including the first reset) and a lifetime cap. If you want to model a separate initial cap, simply enter it as the periodic cap.
Worked Example
Default inputs: $600,000 loan, 25-year term, 2-year initial fixed period at 5.99% p.a., adjusting to 6.99% p.a. after reset, with a 2% periodic cap, 5% lifetime cap, monthly repayments, and a 6.49% fixed-rate comparison.
- Initial monthly payment: $3,862 at 5.99% (25 years, 300 periods)
- Balance remaining after 2-year fixed period: approximately $577,949
- Payment after reset: $4,215 per month at 6.99% for the remaining 23 years
- Maximum possible rate: 10.99% (5.99% + 5% lifetime cap)
- Total ARM interest (if rate stays at 6.99% after reset): approximately $656,020
- Comparison fixed at 6.49%: monthly payment $4,047, total interest approximately $614,248
- In this scenario, the ARM costs approximately $41,772 more in total interest than the fixed rate, because the adjusted rate (6.99%) is higher than the fixed comparison rate (6.49%).
ARM vs Fixed Rate: When Each Makes Sense
An ARM may suit you if you plan to sell the property or refinance before the first rate reset, because you capture the lower initial rate without ever facing the adjustment. It may also suit borrowers who expect market interest rates to fall, because each adjustment could bring a lower payment. A fixed-rate loan provides certainty: your payment does not change regardless of what happens to the OCR or market rates, which can be valuable for budgeting.
Related Calculators
Sources and method: Standard mortgage amortisation formula (P = L x [r(1+r)^n] / [(1+r)^n - 1]). Rate cap structure based on conventional ARM definitions. NZ floating-rate context based on Reserve Bank of NZ (RBNZ) official cash rate framework (rbnz.govt.nz). This calculator is indicative only and does not constitute financial advice. Actual loan terms, rates, and caps vary by lender. Consult a registered financial adviser or mortgage broker for personalised advice.
