- 9 min read
- Should you refinance? Learn how to get a fast answer.
- Weigh several factors when considering ARM refi offers.
- When your best bet is to stay with your existing loan.
What to Consider if You Are Refinancing an Adjustable-Rate Mortgage
Are you considering refinancing your adjustable-rate mortgage (ARM)? Whether you should depends on the specific details of your loan circumstances. If you want a fast answer to your "Should I refinance my ARM?" question, then spend a couple minutes with the Bills.com quick refinance calculator to see if refinancing is right for you. To learn more about the nuances of an ARM refinance, read on.
ARMs have advantages and disadvantages. On the plus side, lenders charge lower initial interest rates for ARMs than for fixed-rate mortgages (FRMs). This makes an ARM easier to afford than an FRM for the same loan amount. An ARM could be less expensive over a long period if, for example, interest rates remain steady or move lower.
On the negative side, when rates adjust upward, you may not able to afford the new, higher payment amounts. This is called "payment shock" when a rate increase pushes up payments beyond what the homeowner can afford. The possibility of interest rates moving up and causing your home loan payment to jump is the major risk and downside to ARM loans.
Quick Tip No. 1
In a fixed-rate mortgage (FRM), the interest rate is locked during the life of the loan. With an adjustable-rate mortgage (ARM), the interest rate changes in relation to an index, and monthly payments may go up or down accordingly.
Big & Small Questions for an ARM Refinance
Whether you should refinance an ARM depends on your circumstances and goals. If you have an ARM and consider refinancing, ask yourself several big questions about the specifics of your loan before you commit yourself to the idea of refinancing. Here are the key questions you need to ask yourself:
- What are your goals or motivations for refinancing your ARM. Are you seeking to:
- Cut your monthly payment?
- Refinance to a FRM with stable payments for the life of the loan?
- How much is the next interest rate adjustment on your existing loan likely to increase your monthly payments?
- Will the next interest rate adjustment be two or three percentage points higher than the current rates offered for either fixed-rate loans or other ARMs?
- If the current mortgage sets a cap on your monthly payments, are those payments large enough to pay off your loan by the end of the original term?
- Will refinancing to a new ARM or a fixed-rate loan enable you to pay your loan in full by the end of the term?
- In which direction do you guess interest rates are headed? (As of late 2012, rates are at historic lows. It is unlikely rates will go lower, and will remain at current levels for a year or more. Long-term, rates can only go higher, and the only question is when.)
- How long do you plan to own the property?
- How many payments remain on your existing loan?
Quick Tip No. 2
A hybrid ARM is a combination of a fixed- and adjustable-rate mortgage. The interest rate remains fixed for a set period of time, then is allowed to adjust afterwards. These are called "3/1 ARM," a "5/1 ARM" or similar. The first number is the number of years the fixed rate remains in effect after the loan is closed. The second number sets how many times per year the rate can adjust after the fixed period elapses.
The eight questions just mentioned are important to understand your particular situation. If, for example, you plan to sell the property in the next three years or so, then refinancing may not make sense. Also, if you are nearing the end of the your existing loan, refinancing to a new loan with a longer term will increase your lifetime interest expense. This may not make sense, unless your payments are unaffordable and you do not wish to sell your home. Again, there is no one-size-fits-all answer to the question, "Should I refinance my ARM?"
What to Watch For When ARM Refi Shopping
Here are the six key points to watch for when ARM refinance shopping:
If your motivation to refinance is affording your monthly payment, then your payment will be your primary focus. If this is the case, then you will probably be refinancing to an ARM because of the lower interest rate than FRMs. Regardless of whether the loan is fixed or adjustable, be aware there is no free lunch when you strive for the lowest possible monthly payment, as we shall see in the discussion of maturity.
Time to maturity
If you can afford your current payment, then refinancing to a low rate and a short term will result in a lower lifetime interest cost than your present loan (assuming the cost of the refinance is reasonable). However, if you cannot afford your current payment, then refinancing to a lower interest rate and a longer term will result in a lower monthly payment. But a longer time to maturity comes at a price. A long time to maturity results in a lower monthly payment, but a higher lifetime interest cost than a short time to maturity, assuming the same interest rate and costs.
If you have an older ARM, it is possible the interest rate you pay now is similar to today's FRM. As mentioned, ARMs have lower initial interest rates than FRMs. However, 95% of Freddie Mac's refinances in 2012 are FRMs, which means homeowners desire the security of knowing their monthly loan payment amount will never increase, even if it means they are refinancing to a higher interest rate.
Paying discount points can be a good deal or bad depending on their cost and the rate you are buying. Decide if the interest rate you get by paying for points is worth the expense, in comparison to what you could get from another lender with fewer or no points. One point equals 1% of the loan. For example, one point on a $85,000 loan is $850. Points paid can sometimes be financed and added to the loan amount. The points a lender charges will depends on market conditions and the loan's interest rate.
Fees - variable
These include application and origination fees, which vary by lender. The application and origination fees cover the lender's costs of doing business. In some cases and situations, the lender's profit is found in these two fees and can be negotiated. The total fee amount often determines whether a refinance makes sense. If, for example, the total refinance fees are low and you plan to reside in the property for the foreseeable future, then it makes sense to refinance, generally speaking. However, if the fees are high and you plan to sell the property in 5 years or less, then it may not make sense to refinance.
Fees - fixed
Fixed fees are set by locale, and include appraisal, surveys, title search, home inspection, lawyer review, mortgage insurance, and recording the title. Some of these fees can be waived in a refinance.
Quick Tip No. 3
Interest rate caps limit the amount an ARM interest rate can increase. A periodic adjustment cap limits the amount the rate can adjust up or down from one adjustment period to the next. A lifetime cap limits the increase over the life of the loan.
Shopping for a new loan is your best and only way to make sure you get the best deal on an ARM refi. Below, find a Refinance Shopping Worksheet that can help you compare the costs of ARM and FRM loan offers. Bills.com recommends ARM refi shoppers talk to at least two lenders to compare costs and rates.
One lender to consider is your existing mortgage servicer (the company you send your monthly loan payment to now). It may agree to waive some closing fees, especially if your work relating to your existing loan is current. Some of these costs that could be waived may be the title search, inspections, surveys, and so on.
Quick Tip No. 4
If you are looking to refinance your home loan, then use the mortgage refinance calculator to determine how much you can save.
Mortgage rates fluctuate from lender to lender. It pays to shop around. Get a mortgage refinance quote from a bills.com mortgage provider to start your loan shopping.
|Refinance Shopping Worksheet|
|FRM 1||FRM 2||ARM 1||ARM 2|
|Name of lender or broker|
|Loan term (e.g., 15 years, 30 years)|
|Loan description (e.g., fixed rate, 3/1 ARM, payment-option ARM, interest-only ARM)|
|Basic Features for Comparison|
|Fixed-rate mortgage interest rate and annual percentage rate (APR) (For graduated-payment or stepped-rate mortgages, use the ARM columns.)|
|ARM initial interest rate and APR How long does the initial rate apply?|
|What will the interest rate be after the initial period?|
|ARM features How often can the interest rate adjust?|
|What is the index and current rate?|
|What is the margin?|
|Interest-rate caps What is the periodic interest-rate cap?|
|What is the lifetime interest-rate cap? How high could the rate go?|
|How low could the interest rate go?|
|What is the payment cap?|
|Can this loan have negative amortization (that is, increase in size)?|
|How much can the balance grow before the loan is recalculated?|
|Is there a prepayment penalty if I pay off the loan early?|
|How long does that penalty last? How much is it?|
|Is there a balloon payment on this mortgage? If so, what is the estimated amount and when would it be due?|
|Estimated origination fees and charges for this loan?|
|Other closing costs?|
|Monthly Payment Amounts|
|Monthly principal & interest payments for year 1?|
|Monthly MPI or PMI mortgage insurance cost?|
|Taxes and insurance? Condo or homeowner’s association fees? If not, what are the estimates for these amounts?|
|Monthly payments in year 2 if the index rate… …stays the same?|
|…goes up 2%?|
|…goes down 2%?|
|The most my minimum monthly payment may be after 1 year?|
|The most my minimum monthly payment may be after 3 years?|
|The most my minimum monthly payment may be after 5 years?|
Source: Federal Reserve Board. Published by the CFPB.