Is it time to refinance your ARM?

There are many ways you can benefit in both the short and long term from refinancing an adjustable rate mortgage (ARM). You may be able to get:

  • A lower margin. If your credit score has improved since you took out your mortgage, you may be able to refinance to an ARM with a lower margin and save. This is because the size of the margin (the amount that’s added onto a specific index to calculate the interest rate you’re charged) is partly based on the credit score you have at the time you apply for a mortgage. A better credit score can mean a lower margin and lower interest payments.
  • More stable payments. One of the downsides of an ARM is that there is always the potential risk of a rise in your monthly payments. In a rising rate environment, you may want to consider refinancing to a fixed-rate mortgage to protect yourself from future rate increases. Alternatively, it may be possible to protect yourself by refinancing to another ARM with more favorable caps -- limits on how much your payments can rise.
  • Faster ownership of your home. Refinancing to a shorter term, say from a 30-year term to a 15-year term, will allow you to pay off your mortgage much faster and save you thousands of dollars in interest payments.
  • Access to your home equity. If you have a good portion of your home already paid off, you might consider refinancing to a new mortgage with a higher principal. You’ll receive the extra amount in cash, which you can use to consolidate debt or make a major purchase.

So how do you know when it’s the right time to refinance your ARM? Consider the following factors:

  • The new rate. As a rule of thumb, it’s worth considering a refinance if your new interest rate will be around 1.5 to 2 percent lower than your current rate. (Otherwise, fees may eat up any potential savings.) Compare your current rate with the posted rates offered by other lenders, but be sure to ask about the index and margin -- if they are different from those of your existing ARM, you may be comparing apples and oranges. The loan’s annual percentage rate (APR) can be a helpful yardstick. Unlike the interest rate alone, it includes other charges or fees to reflect the total cost of the loan.
  • Closing costs. When you refinance -- just like when you took out your original mortgage -- you’ll face fees that can add up and cancel out some of what you’ll save by obtaining a lower rate. Use the LendingTree refinance calculator to help you determine how long it will take for you to break even on the charges.
  • Interest rate trends. ARMs offer an advantage at times of falling interest rates. But if you fear interest rates may rise, you might want to consider refinancing your ARM for a mortgage with a fixed rate and consistent monthly payments. A fixed-rate mortgage will carry a higher rate initially, but locking in when rates are low can save you in the long term.
  • How long you’ll stay in your home. If you plan to move in a year or two, refinancing will generally not pay for itself. Let’s assume that your new mortgage will save you $150 a month and that the cost of acquiring it is $4,500. Your break-even point is 30 months ($4,500 ÷ $150), so you’ll want to stay in your home at least that long to make refinancing pay off.

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