Rising rates may make ARMs riskier

If you have an adjustable-rate mortgage (ARM) and are worried about the prospect of higher interest rates later this year, you might want to consider refinancing to take advantage of today’s still-attractive interest rates on fixed-rate mortgages.

If your ARM has already been reset or is scheduled to reset soon and your new monthly payment won’t be affordable, the decision to refinance your ARM may be simple. Yet the decision still should be made carefully since your mortgage is most likely your largest monthly expense.

In addition to the outlook for interest rates, other factors you should consider include:

  • Your tolerance for risk.
  • The interest rate caps on your current ARM.
  • How long you intend to own your home.

If you refinanced your ARM today with a fixed-rate mortgage, you’d be protected from the possibility of higher interest rates and monthly payments in the future. That’s because a fixed rate means exactly that: The rate never changes over the entire term of the loan, be it 15, 30 or even 40 years. A 30-year fixed-rate mortgage originated today at 6.5 percent would still have that same 6.5 percent interest rate in the year 2038, when it would be paid in full.

Remember that refinancing usually extends the term of the loan, which results in a longer time--and more payments--until the loan is paid off.

Interest rates are already higher today than they were a year ago on 30-year and 15-year fixed-rate mortgages and most ARMs. The good news for borrowers, however, is that loan fees and points are lower, on average, than they were a year ago on some loan products.

Higher interest rates could be on the horizon if inflation, which refers to higher prices, forces the Federal Reserve to hike bank interest rates. The Fed doesn’t directly set interest rates on mortgages, auto loans or credit-cards, but its actions indirectly affect the general direction of rates that consumers pay.

Before you decide to refinance your loan, review your current ARM with your loan officer. Find out how much your interest rate and payment could increase and when each adjustment will occur. How comfortable--or uncomfortable--would you be if the worst-case scenario for your ARM came true? If that scenario makes you queasy, refinancing could be a smart way to protect yourself from that risk.

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