Trying to figure out whether to refinance an ARM into a fixed-rate mortgage can be tricky. That's because your decision-making process must consider multiple factors, and you won't have a complete set of facts. It's just not possible to predict the future of interest rates; all you can do is make educated guesses and minimize the risks.
You should know the terms of your existing adjustable-rate mortgage (ARM), including
- Your current interest rate
- Rate adjustment frequency
- Adjustment caps and floors
- The maximum rate possible
- The highest payment possible.
If you don't know that information, look at your monthly mortgage statement or loan documents or call your loan servicer and ask.
You'll also want to estimate the number of years you'll keep the property and / or the mortgage. You won't know for certain whether market interest rates will rise or fall in the future. That's where the guesswork comes in.
Refinance an ARM
One advantage of refinancing an ARM into a fixed-rate mortgage is that you'll always know what your interest rate and payment will be. That makes budgeting easier.
ARMs typically have caps that limit how much your rate can rise between adjustments and also over the life of the loan. Even with a cap, however, your rate isn't fixed. Refinancing into a fixed rate is one way to end that uncertainty.
The downside is that your new fixed rate could be higher than the current rate for your ARM.
Here's an example:
- Loan balance: $200,000
- Current ARM rate: 3.5%
- Current ARM payment: $898
- Maximum ARM rate: 7%
- Maximum ARM payment: $1,331
- New fixed rate: 5%
- New fixed payment: $1,074
This example assumes your payment is amortized over 30 years and is principal and interest only. That means the payments in the example don't include property tax, homeowner insurance, mortgage insurance or other costs.
If you kept your ARM, your monthly payment could rise from $898 to $1,331. That's the worst-case scenario, though it might never be that high. Your adjustment caps and frequency determine how quickly your rate might reach the maximum and what your rates and payments could be along the way up.
If you refinanced into a fixed rate, your payment would rise immediately from $898 to $1,074, but it would never be higher than $1,074 and certainly never reach $1,331.
When you do your own calculations, remember to include closing costs to refinance, which you could pay out of pocket or through a slightly higher loan balance or slightly higher interest rate.
If you plan to sell your home within a few years, it might not make sense to refinance, because your payment might not rise to the maximum that quickly. If you plan to keep your home for a long time, and you believe interest rates might rise in the future, it could make sense to refinance to eliminate the risk of a higher payment.
Never assume you'll be able to refinance at some unknown time in the future -- for example, right before your ARM rate adjusts. If ARM rates are rising then, fixed rates will also -- perhaps to the point at which it becomes too expensive for you.