If you purchased your home using an adjustable-rate mortgage (ARM), you may be looking at current mortgage rates with an eye toward refinancing. Does refinancing make sense in today's lending market, and what should you consider before taking the plunge? Read on to learn more about refinancing from an ARM into a fixed-rate loan to lock in a lower interest rate, as well as a few situations in which choosing another ARM -- rather than a fixed-rate mortgage -- may be your best bet.
Is refinancing your ARM into a fixed-rate mortgage a good idea?
Most ARMs today are hybrid loans containing a "reset" timeline that allows the interest rate to be adjusted after an initial period of fixed-rate interest. For example, a 5/1 ARM will operate as a fixed-rate mortgage for 5 years, then adjust to the current market interest rate after this 5-year period has ended. Other mortgages have shorter or longer reset periods available at comparable interest rates.
If mortgage rates in your area have gone down between the time you first took out your ARM and the end of the reset period, the ARM's interest rate (along with your mortgage payment) will decrease. If interest rates have risen during the interim, your mortgage payment will instead increase. Most ARMs have mechanisms built in to prevent your interest rate from skyrocketing too rapidly over a short period of time.
Because current mortgage rates are still much lower than they've been over the past few decades (but are poised to increase soon), now is likely a good time to refinance your ARM into a fixed-rate mortgage at a competitive interest rate. It's likely that by the time your ARM resets, mortgage rates will have risen -- locking you into a higher rate and higher payment than you'd have after refinancing into a fixed-rate loan.
When should you refinance an ARM into another ARM?
While a fixed-rate loan can provide you with the security of knowing you'll always owe the same amount each month, there are a few situations in which trading in one ARM for another can be a savvy decision.
The first is if you're planning to move in the near future. Because ARM rates are still low, your payment is unlikely to increase until the reset period on your new loan -- and if you plan to be long gone by that point, locking into an ARM that will be satisfied upon the sale of your home can allow you to enjoy a lower interest rate for a while longer.
Another situation in which an ARM may be advantageous is if you're planning to prepay your mortgage quickly enough so that it will be fully or mostly paid off by the time the interest rate resets. While you can prepay a fixed-rate mortgage as well, the prospect of sticking yourself with a higher interest rate if your mortgage isn't satisfied before the ARM resets can often be an incentive to pay this loan off even more quickly.