Should you refinance an adjustable-rate mortgage?
If you have an adjustable-rate mortgage (ARM) you may be wondering if it would be safer to take advantage of a fixed-rate home loan instead. As with any mortgage decision, the answer is "It depends." Every mortgage, whether it carries a fixed interest rate or an adjustable one, should be suitable to meet the homeowners' budget and their financial goals.
Refinancing an ARM
There are two important terms to understand when it comes to your ARM: "margin" and "caps." Before you decide to refinance your ARM, you need to know how your current mortgage may adjust. The margin is the markup over the index which governs the interest rate changes on your ARM. The sum of the index value plus the margin will give you your loan's new interest rate for your next period, subject to rounding and any interest rate limits, or "caps." The cap tells you the maximum amount the interest rate can increase over the entire loan. For example, a 5/2/5 ARM can increase by five percent at the first reset, by two percent at each reset and by a maximum of five percent over the original interest rate.
A mortgage calculator can help you estimate your monthly payments at various interest rates so you can decide if you are comfortable with the highest possible interest rate your ARM contract will allow at each reset.
Life plans and ARMs
Once you have the numbers at your fingertips, you can check mortgage rates to see how the interest rates compare. Some homeowners prefer to take advantage of low mortgage rates and lock in a fixed-rate home loan rather than risk future higher mortgage rates with an ARM.
Whether you have an ARM or a fixed-rate home loan, part of the process of deciding to refinance should be to develop a plan for how long you intend to stay in your home. If you know for certain that you will be moving within a few years, sticking with your current ARM or refinancing into another ARM could save you money on interest payments. If you intend to stay for seven years or longer, a fixed-rate loan may be a better option.
Consult with a mortgage lender to discuss your individual financial needs and how either a fixed or adjustable-rate mortgage can help you meet your goals.
Michele Lerner contributed to this answer
A 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.