Adjustable rate mortgages (ARM) are normally considered quite risky, and many people find themselves looking for a suitable time to refinance their ARM mortgage. Refinancing an ARM into a fixed-rate mortgage may start with a slightly higher initial payment, but over the long run it would offer significant financial savings. One reason for choosing an ARM over fixed-rate is its lower initial charge. But, the rate increases over time, making it a good idea to refinance an ARM into a fixed-rate loan after the initial period.
One of the ways to justify your ARM refinancing lies in the nature of your ARM rate caps. ARM caps can give short-term benefits; however, they may not be very protective against long-term interest rate increases. During a steady rise in interest rates people tend to refinance their ARM into fixed-term mortgages. Refinancing an ARM does not come without a cost. The upfront cost of refinancing may only be beneficial for you over the long run, in the event that you plan to live in your home for several years.
You may also consider refinancing your ARM to protect the mortgage against rate reset shock. Though any ARM initially comes with a lower rate, after a rate reset the interest rate can rise significantly, producing a noticeably larger monthly payment. In the case of a hybrid ARM, the rate reset is more dramatic and may even see an increase in your principal loan. Considering these facts, you should keep an eye on the rate reset date and refinance into a fixed rate mortgage, before your mortgage absorbs the new rate. You can also pay off some of your principal loan before the ARM resets, if that does not incur a prepayment penalty.
After refinancing, if your monthly payment increases due to debt consolidation or the nature of the refinanced product, you should work to curtail your unnecessary spending, consider taking in tenants, or even look at the possibility of downsizing if you don’t have any other appropriate options.
There are both immediate and long-term benefits to ARM refinancing. If you refinance to reap the benefit of your improved credit score, you will see a reduced margin and a lower interest rate. Refinancing will also save you from fluctuating payments, and you will be able to take the ownership of your property more quickly.
Although you can easily benefit from refinancing your ARM mortgage, there are certain conditions that make refinancing a suitable option. When interest rate drops significantly, by 1 or 2 percent, you can refinance your ARM relatively easily; such a rate decrease will easily cover your refinancing costs. Refinancing is costly in most instances, and you should carefully consider whether the amount saved after refinancing will outweigh the refinancing cost. You may also consider refinancing if you find the interest rates are trending upward and you expect your interest rate will be greatly affected.
Another purpose of refinancing is reevaluating your plan regarding the property, particularly how long you plan to stay in the property. It is unnecessary to consider refinancing during every interest rate increase, because the caps and adjusted period set on your ARM may save you from an initial interest rate increase for a while. However, it is always better to research the market analysts’ reports and forecasts in terms of interest rate increases.
Most of the time, consumers refinance their ARM into a fixed-rate term mostly to avoid the increased interest rate. However, depending upon the nature of your existing ARM, you may consider switching into a hybrid ARM, a more stable indexed ARM or an ARM with better caps.
Is it a good idea to refinance your ARM before its reset date?
It may be worth refinancing your adjustable-rate mortgage (ARM), even if it means paying slightly more now. You could drastically reduce your interest charges in the long-term.
Borrowers tend to opt for adjustable-rate mortgages (ARMs) instead of fixed-rate loans because they initially offer lower monthly repayments. Eventually, though, the rate and monthly payments are adjusted. For instance, if you opt for a 5/1 ARM, the adjustment will take place after 5 years. Every year after that initial period, your ARM will be re-adjusted. Although you will be positively affected when interest rates are falling, your monthly payments could increase significantly when rates are on the rise.
Here is a short guide to help you decide whether refinancing may be of benefit.
The rate caps on your ARM
If the interest rate on your ARM is due to reset in the near future, you need to know what the caps are on your home loan. Caps are a safety feature, as they limit the rise in your interest rate and monthly payments, thus protecting you from extreme interest rate increases. The three main caps commonly used are:
● initial caps: these prevent your interest rate and monthly payments from increasing dramatically when the interest rate is first re-adjusted.
● periodic caps: these state the maximum interest rate rise you can face each time your ARM adjusts.
● lifetime caps: these limit the total interest rate increase that can be applied to your mortgage during its entire life.
For instance, you hold a 3/1 ARM which bears an initial rate of 4 percent. Both your initial and periodic caps have been set at 2 percent, while the lifetime cap is an increase of 6 percent. Your mortgage is due to reset in one month and you have noticed that interest rates have increased since you took out your loan. If your new fully-indexed rate had gone up to 6.5 percent, the initial cap on your loan would mean your actual rate would stay at 6 percent.
If interest rates have remained the same after 12 months, your ARM will increase to 6.5 percent when it is adjusted. This is because a 0.5 percent increase is well below your 2 percent periodic cap. If interest rates continue climbing, the interest rate on your mortgage will climb too. However, it will only climb a maximum of 2 percent each year until you reach 10 percent, which represents the lifetime cap. In other words, although caps offer some degree of protection, they may not be effective long-term against interest rate rises.
Steadily rising interest rates
If you expect interest rates to steadily rise in the future, you may find it advantageous to refinance your current ARM before it resets, unless you are planning to move in the next couple of years. If you lock in for several years, you will protect yourself from increasing interest rates.
For instance, you hold an ARM with carries a principal of $200,000 and still has 25 years left on the loan. Your interest rate, which is currently 4 percent, is due to reset in twelve months’ time and you expect the rate to jump to 5.5 percent. You believe the rate will rise to 6.5 percent in two years’ time and will increase by another 0.5 percent in years three and four. Your monthly payments would increase as follows:
| Current | In 1 year | In 2 years | In 3 years | In 4 years | |
| Interest rate | 4% | 5.5% | 6.5% | 7% | 7.5% |
| Monthly payments | $1,056 | $1,222 | $1,337 | $1,394 | $1,450 |
Instead, you could choose to refinance your mortgage now, 12 months before your existing loan resets, and opt for a 5/1 ARM with an initial rate of 5.75 percent. In this instance, although the interest rate is 1.75 percent higher, it would remain the same in the first five years. Your new monthly payment would be much higher in the first twelve months, namely $1,258. It would also be slightly higher the following year but you would start saving money after that. In fact, you would pay around $2,000 less in interest charges in the five-year period.
The upfront costs of refinancing
Remember that if you decide to refinance your ARM, you will be charged upfront costs. You should be able to recoup these charges and save money, provided you remain in your home for several years. Also, it can be difficult to predict whether interest rates will rise or fall in the next twelve months, let alone in the next few years. In other words, the interest rate of your ARM may well fall.
If you would like to find out how your monthly repayments will be affected when your adjustable-rate mortgage resets, use the RateWinner adjustable rate mortgage payment calculator.
ARM rate reset shock: How can you protect yourself?
Are you concerned about the prospect of higher interest rates? Here is some advice to lessen the effect of ARM rate reset shock.
You can benefit from an adjustable-rate mortgage (ARM). Usually, the interest rate associated with such a mortgage is initially lower than that of a fixed-rate mortgage. However, ARMs also have a disadvantage: when they reset, the interest rate payable will rise and your monthly payments can increase significantly. When this occurs, this is commonly described as “ARM reset shock”.
“ARM reset shock” affects borrowers when the initial introductory rate expires and the interest rate is increased to reflect the current rate. In addition, if interest rates have risen during the introductory period, your monthly payments will increase significantly.
In the case of hybrid ARMs, which come with a reduced initial rate that is fixed for a period of two to five years, the rate shock can be even more dramatic. Indeed, you can easily get used to lower payments, even if those are only temporary. However, interest rates can rise significantly following the fixed-rate period, and so can monthly payments. Both could even continue rising every six or twelve months, depending on your adjustment period.
The effect of the rate reset can be even greater if you hold an ARM which has a discounted initial rate: a rate which is lower than its fully-indexed rate. For instance, your lender offers you a $200,000 home loan with a 30-year term, an initial 12 months’ discounted rate of 4 percent and a fully-indexed rate of 6 percent. If we base our calculations on the Federal Reserve Board’s Consumer Handbook on Adjustable Rate Mortgages, the monthly payments in the first twelve months would be $954.83. When the initial discounted rate expires, these would jump to $1,192.63. Additionally, if interest rates had also increased by a full percentage point during that same twelve-month period, your monthly payments would amount to $1,320.59, because the rate would now be 7 percent (original fully-indexed rate of 6 percent + additional 1 percent). This would represent a total increase of $365.76 a month.
Similarly, if you have been paying the smallest amount possible on an option ARM, you could also experience another type of reset shock. In fact, minimum payments do not usually cover the total interest payable on the mortgage. In other words, the principal on your home loan may have been increasing. When the time comes for your option ARM to be reassessed, most commonly after five years, the higher balance is used. Your monthly payments could increase dramatically, especially if interest rates have also crept up. Unfortunately, the rate cap does not apply in this circumstance.
If you hold an adjustable-rate mortgage, make sure you know when your reset date is scheduled. Here are a few tips to help you cope with potential rate shock when your reset date arrives:
● You can refinance to a fixed-rate mortgage before the reset date. Although your monthly payments may be higher, you will not be affected by future increases. Make sure you double-check whether you will incur prepayment penalties. Also add up all the costs associated with refinancing before choosing this option. If you are not planning to remain in your home for very long, refinancing is unlikely to be suitable for you.
● Open a savings account. You can then pay off some of your principal when your ARM resets. Before doing so, ensure you will not incur a prepayment penalty.
● Try to increase your monthly payments so that they exceed the minimum amount if you hold an option ARM. Doing so will decrease the principal on your mortgage when your option ARM is recalculated. If you are unable to do so, talk to your lender about switching to the interest-only option. This way your mortgage balance will remain the same.
● Consider debt consolidation. If you know you will struggle with greater monthly payments, consult a credit counselor. You might be able to restructure part of your high-interest debt. Consolidating your high-interest date into a lower-interest loan may enable you to meet your higher mortgage payments.
● Curtail your spending. Try and cut other costs if at all possible. These include gym memberships, cable, broadband internet, and so forth.
● Consider taking in tenants if your property allows you to do so. The extra cash could enable you to afford the higher monthly payments.
● Consider downsizing. If you have run out of options, downsizing may be the only solution for you. Selling your property and moving into a smaller home would enable you to meet your monthly mortgage payments more easily. It is certainly preferable to defaulting on your home loan. Once you have managed to build up some equity, you can then move back into a larger property.
If you hold an adjustable-rate mortgage and would like further information, visit RateWinner ARM Central.
When should I consider refinancing my adjustable-rate mortgage (ARM)?
If you hold an adjustable-rate mortgage, you might find refinancing beneficial. Here is a short guide to help you decide.
If you decide to refinance your ARM, you could enjoy both immediate and longer-term benefits such as:
● A reduced margin. If you have managed to raise your credit score since you first took out your mortgage, you may benefit from a reduced margin when you refinance your ARM. The margin, or the percentage a lender adds to the index value to calculate the interest rate of an ARM, is partially based on your credit score when you apply for a home loan. As a result, a higher credit score should mean a lower margin and interest charges.
● Less fluctuating payments. When you hold an ARM, there is always the risk that your monthly payments will increase. If interest rates are on the rise, you may wish to opt for a fixed-rate mortgage to avoid future interest rate increases. Another option would be to look at other ARMs, especially those offering more advantageous caps, in order to reduce any potential increase in your monthly payments.
● Taking ownership of your property more quickly. By choosing a mortgage which has a shorter term, you will be able to pay off your home loan earlier. For instance, by changing your term from 30 to 15 years, you could end up saving thousands of dollars in interest charges.
● Free up some of your home equity. You may wish to consider cash-out refinancing if you have already paid off a good proportion of your home loan. By taking out a mortgage with a higher principal, you would receive a cash payment which you could use to consolidate your debt or finance a major expense.
How do you determine whether the time has come for you to refinance your ARM? You need to carefully look at the following:
● The new interest rate. Generally, if you are offered an interest rate which is 1.5 percent to 2 percent lower than your existing interest charges, you should find refinancing beneficial. Indeed, such a drop in interest rate should cover the refinancing costs easily. When weighing your existing rate and current rates offered by lenders, make sure you inquire about indexes and margins. If they vary from those of your current ARM, you will not be comparing equivalent products. In fact, instead of looking at the interest rates alone, you should compare the various loans’ annual percentage rates (APRs), as these take the various costs of the loans into account.
● Closing costs. Refinancing can be costly, so you need to work out whether the charges associated with taking out a new loan will outweigh the savings you will get from taking out a loan with a lower interest rates. Use the RateWinner refinance calculator to work out how quickly you will break even when you refinance.
● Interest rate fluctuations. Adjustable-rate mortgages offer advantages when interest rates are decreasing. If interest rates are on the rise, or if your expect interest rates to start increasing, refinancing to a fixed-rate home loan would enable you to benefit from fixed monthly payments. Although fixed-rate mortgages have a higher interest rate to start with, locking in will save you thousands of dollars over the life of the loan.
● How long you anticipate to stay in your property. If you are likely to move in the next couple of years, refinancing is unlikely to be worthwhile. For instance, if your refinancing costs are $4,800 and refinancing can save $160 each month by taking out a new mortgage, your break-even point will be 30 months (4,800 – 160). You would then need to remain in your home for at least that amount of time to recoup your refinancing costs.
Should you refinance your ARM now?
If your ARM loan is due to reset soon, you should find out whether refinancing could be worthwhile.
Most borrowers choose an adjustable-rate mortgage to benefit from the introductory interest rate which keeps their monthly repayments low for a few years. However, when the time comes for your ARM to adjust, you may be faced with much higher monthly payments.
Because there is a chance your payments may increase even more, you may decide to look for another loan to replace your ARM. But, try not to rush into making a decision.
A few points to consider before refinancing your ARM
Obviously, you will want to compare how much more you will be paying if you allow your current mortgage to reset with what another mortgage would cost you each month. However, you should also remember to look at the caps and adjustment periods on your existing mortgage. Because refinancing a mortgage is costly, the charges are well worth considering, along with the prospect of higher or lower interest rates. Don’t forget that the longer you remain in your home, the more sense refinancing makes.
Even if interest rates continue to increase, the caps and adjustment periods built into your ARM should protect you from significant changes in your monthly payments. Although interest rates’ movements are sometimes hard to anticipate, keep an eye on what market analysts expect will occur in the future.
Refinancing can be time consuming. You will need to do a significant amount of research before you reach the closing stage. Switching mortgages is also an expensive process. Unless you are planning to remain in your home for many years, refinancing may prove to be a mistake. Also, remember that a higher loan payment could be offset by higher tax deductions. It might be worth consulting your tax advisor to discuss this further.
A new mortgage may or may not be advantageous
A new fixed-rate mortgage may not mean lower monthly payments, especially if interest rates have gone up since you took out your existing mortgage.
In addition, if you decided to refinance with a loan which puts off the date of your final payment, you would end up paying more interest. For instance, if you have been paying your 30-year ARM for the past five years and decide to refinance into another 30-year loan, you would pay off your home five years later than anticipated. Lower monthly payments might therefore not make financial sense, since you will have to make an extra sixty payments before you own your property and will incur additional interest charges.
However, a new mortgage may still provide benefits. Choosing a fixed-term loan would ensure you do not have to face even more interest rate increases.
Adjustable-rate mortgages provide benefits too
Do not rule out the possibility of refinancing an ARM with another ARM. There are several types of adjustable-rate mortgages, and although switching from one type to another would not fully protect you from interest rate increases, a suitable ARM could limit any potential rise in rates. You should approach lenders to find out how this could be achieved.
Do not overlook the advantages an adjustable-rate mortgage possesses over a fixed-rate loan. For instance, if interest rates decrease, your monthly payments would also decrease with an ARM, whereas they would remain the same with a fixed-rate mortgage. However, in general and for obvious reasons, ARM’s are considered riskier than fixed-rate mortgages.
You can avoid the pain of rising interest rates by refinancing your ARM
Are you concerned that you may not be able to afford your adjustable-rate mortgage (ARM)repayments if interest rates rise? You should look into mortgage refinancing.
Interest rates can sometimes increase very quickly. Refinancing your ARM could give you peace of mind. Here are some suggestions to keep your monthly payments stable.
Fixed-rate home loans
You probably decided to opt for an ARM to take advantage of a lower interest rate to start with. But if you are now struggling with higher monthly payments, or if you are concerned you may no longer be able to afford your mortgage repayments if interest rates rise further, you should look into swapping your current mortgage for a fixed-rate home loan. The rate you will be offered is likely to be higher than your existing ARM rate but your monthly payments will remain the same for the full term of your loan.
Hybrid ARMs
You may wish to opt for an hybrid ARM instead. The interest rate with these mortgages is fixed for a few years, generally between 3 and 10 years. Once the initial period runs out, the interest rate will be adjusted periodically, usually once a year. Hybrid mortgages offer lower interest rates compared with 30-year fixed-rate loans. Furthermore they offer stability in the medium term. If you think interest rates will soon stop rising and will settle or start to fall again, you may wish to consider a 3/1 or a 5/1 ARM. In these two examples, the 3 and the 5 indicate how long the fixed-term will last (3 and 5 years respectively). The second number shows how regularly your mortgage will be adjusted following the fixed-term period (in this example, 1 year).
ARMs with a more stable index
Rising interest rates will obviously have an impact on your ARM. Each time it is adjusted, your interest rate will rise or fall depending on a particular index. Because some indexes are subject to more volatility than others, that is, they rise or fall more significantly compared with other indexes, you may wish to choose an ARM which is governed by a more stable index. This will protect you from large interest rate variations.
ARMs with better caps
Your ARM may have a cap which allows large rate increases, and hence substantial rises in your monthly payments, each time your mortgage is adjusted. By opting for an ARM which has a more favorable cap, you can protect yourself from large interest rate increases.
Do you still have questions? Call 1-888-262-0715 to speak with one of our loan consultants.
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