If you are among the homeowners who opted for an adjustable-rate mortgage (ARM) to avoid the rise in fixed-rate mortgages that began in 2022, you may be considering refinancing soon. With ARM rates now adjusting to 7% APR or higher, significant payment hikes could be looming. For instance, if you secured a 5/1 ARM at 4.5% five years ago on a $400,000 mortgage, your monthly payment might soon increase from $2,027 to around $2,661 — an additional $634 each month. However, there is potential good news on the horizon. Some experts foresee fixed interest rates dropping to approximately 6% APR by 2025. If this occurs, seizing the opportunity to lock in a lower fixed rate through refinancing could prove beneficial. Here’s what you should consider before transitioning from your ARM to a fixed-rate mortgage.
In this article:
– Understanding adjustable-rate mortgages
– Assessing the timing for converting your ARM to a fixed rate
– Steps to refinance your ARM
– Tips for saving money through refinancing
– Exploring refinancing alternatives
Adjustable-rate mortgages: The basics
An ARM is a mortgage that commences with an initial fixed-rate period — typically ranging from 3, 5, 7, to 10 years — offering rates that might be lower than those of a traditional fixed-rate loan. Once the initial rate period concludes, the rate becomes variable, adjusting periodically based on market indexes. ARMs are denoted by two numbers separated by a slash, such as a 5/1 ARM loan. In this example, the 5 signifies the duration your rate remains fixed, while the 1 represents the frequency of rate adjustments thereafter. With a 5/1 ARM loan, adjustments occur annually.
Decoding common adjustable-rate mortgages:
Type – Fixed period – Adjustment frequency
5/1 ARM – 5 years – Once per year
7/6 ARM – 7 years – Every 6 months
10/1 ARM – 10 years – Once per year
3/6 ARM – 3 years – Every 6 months
ARMs can be advantageous in high-rate markets, potentially offering lower introductory rates compared to fixed mortgages. For instance, while the average fixed-rate mortgage surged by 4.22% from December 2020 to October 2022, ARMs only increased by 2.92%, enabling many to save on monthly payments. As home loan rates hit record highs in early 2023, the popularity of ARMs skyrocketed, comprising 15.5% of mortgage originations by mid-2024. Nevertheless, given the evolving market conditions, an ARM may not be the optimal choice presently. Many fixed-rate mortgages now present lower interest rates than ARMs, with the average 30-year fixed mortgage rate hovering around 7%, compared to approximately 6.30% for a
ARM loans are based on a market index plus a margin after a fixed period or your starting rate plus a change in index. The monthly payments are lower initially and may increase or decrease later. However, the payment remains the same for the life of the loan. Lender fees and risk levels are similar to those of traditional loans.
ARM loans are best suited for shorter-term borrowing, typically between 3 to 10 years, while fixed-rate mortgages are more suitable for longer-term borrowers.
Here are five key questions to help determine if refinancing your ARM to a fixed-rate mortgage makes sense:
1. When does your fixed-rate period end?
– Within 6 months: Time to start comparing rates now
– 6 to 12 months away: Begin your research and credit preparation
– More than a year away: Keep monitoring rates, but no rush
2. How long do you plan to stay in your home?
– Long-term or forever home: Good candidate for fixed-rate refinancing
– 3 to 5 years: Could go either way, calculate your break-even point
– Moving within 2 years: Your ARM might still be your best bet
3. Has your financial situation changed?
– Improved credit score
– Stable income
– Savings for closing costs
4. How’s your monthly budget?
– Need strict predictability: Fixed-rate mortgage would be best
– Can handle some changes: Still might prefer fixed rates for peace of mind
– Very flexible budget: Your ARM might still work well
5. What’s your current ARM experience?
– Already seeing payment increases: Time to explore fixed rates
– Concerned about future adjustments: Start researching options now
– Managing fine but want more stability: Good time to compare rates
If your answers align with the first bullet point of most questions, particularly questions 1, 2, and 4, it might be time to consider refinancing. Schedule a chat with a mortgage advisor to review your situation.
However, there are scenarios when keeping your ARM might still be the best choice:
– Short-term housing plans
– Competitive current rate
– Anticipating rate drops
– Financially prepared for fluctuations
– Refinancing costs are not justified
If you decide to refinance your ARM, follow these steps:
1. Review your current loan terms
2. Research and compare fixed-rate mortgage options
3. Check your credit score
4. Gather necessary financial documents
5. Contact a mortgage lender to start the refinancing process.
Here are the steps to consider when reviewing your current mortgage details and preparing for a refinance:
1. Assess your existing mortgage:
Begin by collecting information about your current adjustable-rate mortgage (ARM). Obtain your latest mortgage statement, identify your interest rate and adjustment schedule, and determine if there are any prepayment penalties. Calculate your remaining loan balance to understand the amount needed for refinancing.
2. Evaluate your financial status:
Before applying for a refinance, assess your financial situation. Check your credit history and score, aiming for a score of at least 620, with better rates available for scores above 740. Obtain a free credit report from AnnualCreditReport.com to check for any inaccuracies. Improve your credit score by making timely payments and reducing credit card balances. Calculate your debt-to-income ratio, aiming for a ratio below 43% when considering all loans. Allocate funds for closing costs, typically around 2% to 5% of the loan amount.
3. Compare lenders:
Research multiple lenders to find the most favorable offer. Compare rates, terms, and incentives from at least three lenders. Explore different loan lengths, such as 15- or 30-year terms, and inquire about special programs. Request written loan estimates for accurate comparisons and ask about relationship discounts if you have existing accounts with the lender.
4. Proceed with your chosen lender:
Complete the loan application and submit necessary documentation like tax returns, bank statements, and employment verification. Consider locking in the interest rate for your new loan, typically lasting 30 to 60 days or more, to safeguard against rate fluctuations (fees may apply).
5. Finalize your mortgage refinance:
Schedule a home appraisal and review the closing disclosure meticulously, detailing the final terms and costs of the loan. Prepare your closing funds, usually due 24 hours before closing via wire transfer or certified check. Sign the final documents to complete the mortgage refinance process.
Remember that these steps are general recommendations, and lenders may have varying requirements and terms. It’s advisable to compare offers from multiple lenders to secure the best deal that aligns with your financial goals and borrowing needs.
Consider these tips for refinancing your mortgage:
One way to start saving money is by opening a checking account or setting up automatic payments, which can be an easy win for many customers.
Improving your credit score before applying for a refinance is crucial. Raising your score from 680 to 740 could potentially drop your rate by 0.5%, saving $130 monthly on a $400,000 loan.
It’s important to understand your break-even timeline when considering refinancing. For example, if refinancing costs $6,000 and saves you $200 monthly, you’ll break even in about 30 months. If you plan to stay in your home longer than that, refinancing could make sense.
Before jumping into a full refinance, explore alternative options that might better suit your situation. These options include loan modification for financial challenges, FHA Streamline refinance for FHA loan holders, VA Interest Rate Reduction Refinance Loan for VA loan holders, rate-and-term refinance, and Home Equity Conversion Mortgage for older homeowners.
Consult with a trusted financial advisor to determine which refinancing option aligns best with your retirement goals and financial situation.
Additionally, stay informed about mortgages, borrowing costs, and saving money by exploring personal finance guides and resources.
If you’re considering refinancing an ARM mortgage, be sure to check for prepayment penalties in your loan agreement. Timing your refinance based on market conditions and your ARM’s adjustment schedule can help you lock in substantial savings.
When switching from a variable to a fixed-rate mortgage, consider the current interest rates and your financial goals to make an informed decision.
I need to assist you in refinancing your current mortgage into a new loan. To qualify for this process, you will need to meet certain criteria based on your current credit and income. Additionally, you will be required to pay closing costs, which typically range from 2% to 5% of the loan amount.
Are you wondering whether having a cosigner can help you secure a lower mortgage rate? Having a cosigner who shares legal responsibility for your loan may indeed assist you in obtaining better mortgage terms and rates. However, it’s important to note that lenders typically base their rates on the lowest credit score among all applicants. Before considering asking someone to cosign, carefully weigh the benefits and risks to your relationship.
Curious about the drawbacks of getting an Adjustable-Rate Mortgage (ARM)? One significant downside of an ARM is the financial uncertainty it brings after the initial fixed-rate period concludes. Your monthly payments could increase significantly, potentially impacting your budget and financial goals.
As part of the loan application process, a lender may inquire about your age. It’s important to know that while a lender or broker can ask about your age, they are not allowed to deny your application solely based on this factor. Your age is typically included on an application as part of the usual personal information gathered by lenders or creditors. It is one of many factors considered alongside your income and credit score. Remember, the only age requirement is that you must be at least 18 years old.
Have you ever wondered what happens to your mortgage after you pass away? Mortgages are treated differently from other debts, and the way you structure your will and estate plan can greatly impact what happens to your mortgaged home after your death. Proper planning can ensure that you leave behind a valuable asset for your surviving family members. To learn more about this topic and steps you can take to avoid complications for your loved ones, refer to our guide on mortgages after a death.
For more information on rising rates and Adjustable-Rate Mortgage (ARM) activity, you can consult sources such as CoreLogic. Additionally, to stay informed about the current mortgage and housing market trends, refer to resources like “10 Things to Know About the Mortgage and Housing Market Right Now” by CoreLogic.
Our writer, Kat Aoki, is a seasoned finance writer who has contributed thousands of articles to help people better understand technology, fintech, banking, lending, and investments. Her expertise has been recognized on platforms like Lifewire and Finder, with featured content at leading technology brands in the U.S. and Australia. Kat’s goal is to empower consumers and business owners to make informed decisions when selecting financial products that suit their needs. This article has been edited by Kelly Suzan Waggoner for accuracy and clarity.
