Is Now the Time for an ARM Refinance?

An ARM refinance is often a good idea, especially when rates seem poised to rise. According to the National Association of Realtors ,interest rates are expected to reach 5.4 percent in 2015, better than a full percent higher than the rates we have today. On the other hand, predictions are not necessarily right: the NAR also predicted 5.4 percent rates for 2014 but that has (so far) not happened.

Still, you get the idea. If you have an ARM, you can get hit with a higher rate and payments. This raises the question: Is now the time for an ARM refinance?

ARM Refinance by the Numbers

Let's imagine two borrowers have two loans for $150,000. One is a fixed-rate mortgage at 4.12 percent while the other is a hybrid 5/1 ARM with a 2.99 percent rate for the first five years, the actual rates in September 2014 according to Freddie Mac. The monthly payments for principal and interest are $726.54 for the fixed-rate loan versus $631.60 for the ARM. During the first five years of the loan term, the fixed-rate borrower will pay out $43,592 versus $37,896 for the ARM borrower.

Given such monthly costs, it's enticing to keep the ARM and its lower monthly costs. The problem is that rates might rise, and if they do, the ARM borrower might get hit with much higher monthly payments.

If the ARM interest rate can rise as much as two percent when the loan re-sets and as much as two percent more each year thereafter up to its lifetime cap of 8.99 percent (the original 2.99 percent rate plus 6.0 percent, which is typical) here's how a potential monthly principal and interest payment might increase:

  • Years 1 through 5: $631.60
  • Year 6: The mortgage balance has been reduced to $133,335. At 4.99 percent (2.99 + 2.00) the new monthly payment is $714.96.
  • Year: 7: The rate again rises a full two percent so the full rate will 6.99 (4.99 + 2.00). The loan balance has dropped to $131,364. The new monthly cost is $873.09.

Will the interest rate jump the maximum two percent each time the loan re-sets? No one knows. With an ARM, rates can rise and fall, so it's possible that monthly costs could go lower when the rate is adjusted.

What IS known is this: even if rates increase as much as possible in this example, it will take at least seven years before ARM monthly costs top the principal and interest payments paid by a fixed-rate borrower. The amount of time a homeowner expects to keep the property and the mortgage is important in the decision to refinance.

What About Inflation?

Those who expect to be short-term owners might want to keep their ARMs. However, those who expect to be long-term owners might want to refinance now, while rates are at current low levels.

It's true that refinancing today will mean a higher monthly payment in the above illustration, but monthly payments are not the only issue. For instance, if you expect to retire with a set income, it may be very important to have a fixed monthly payment rather than an adjustable cost that can rise. Also, if you believe that today's interest levels cannot be maintained, that inflation is a real threat to the economy, then the ability to get an ARM refinance and lock-in a mortgage rate at today's pricing is not something to ignore.

For more information, speak with mortgage loan officers and compare today's options with what you have. Who knows, if you like your current loan then maybe the right approach is to get a new ARM and effectively extend your start period for another five or seven years.

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