How it works
An adjustable-rate mortgage (ARM) is a home loan option that comes with a variable interest rate that changes over time depending on the benchmark interest rate. The advantage this offers the borrower is that if the interest rate goes down, so does the interest rate. On the other hand, if the interest rate rises, so will that of the borrower.
This, in part, is why many prefer to have a fixed rate when it comes to their mortgage so that they are not at the mercy of the market or industry rate fluctuations. For those who go with an ARM, there is an introductory period of time where the interest rate is fixed. After that period, interest rates on the remaining balance of the loan will reset monthly or yearly to reflect the current market interest rate benchmark.
Why do borrowers choose an ARM?
Many ARM borrowers obtain the loan at an initially lower rate than other loans with a fixed rate. ARM loans are often the most attractive option when interest rates are high. Selecting an ARM allows a borrower to get a lower interest rate than most fixed-rate loans can provide, which is excellent for individuals who want to get ahead by paying down the loan faster while they have access to a lower rate.
After that initial period, which often lasts anywhere from six months to ten years of the loan term, the interest rate will adjust depending on industry benchmarks. Once the initial period is over, many borrowers choose to refinance to a fixed-rate mortgage. Refinancing can help the borrower achieve a stable monthly payment without the stress of fluctuating interest fees.
When to refinance an ARM
Depending on your loan terms, the interest rate will most likely adjust every six months for most with an ARM. If you have an ARM and the initial fixed-rate period is about to end, and you're concerned about your interest rate going up, a refinance to a fixed-rate mortgage might be the right move for you.
In fact, interest rates have begun to rise to pre-pandemic levels, so the longer you wait to refinance, the higher your mortgage rate and monthly payments will be. Other benefits that may come with a refinance could include:
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Lowering your monthly payment
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Shortening your loan term
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Allowing you to borrow your available home equity as cash
When to hold off on refinancing an ARM
There is always the possibility that refinancing to another loan could end up costing you more in the long run. For example, if you refinance into another 30-year mortgage term, you may end up paying more in interest expenses. Additionally, closing costs are another factor to consider when deciding whether a refinance will save you money over the life of your loan.
It's vital to keep in mind that there is a possibility that you may end up paying more in the short term when refinancing into a fixed-rate mortgage. But, the important thing is that you are locking into a reasonable rate and regular monthly payment. So, in the end, it is worth the effort required to refinance if you can save in the long-term, access a lower interest rate, or pay your home off sooner.
Pros
You may want to consider a refinance to a fixed-rate mortgage if you:
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Want a shorter loan term
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Want to pay off your loan sooner
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Need the consistency of a fixed-rate mortgage
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Want to avoid interest rate increases when your initial period is over
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Want to access a lower interest rate that may be lower than your ARM rate
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Are looking to access your home's equity as cash
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Are getting a divorce and need to remove someone from the mortgage contract
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Believe a fluctuating interest rate will put undue stress on your finances
Cons
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Refinancing takes time
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Refinancing demands quite a few resources
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Fees and closing costs can add up
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It may not end up saving you much money in the long run
Refinancing options to consider if you have an ARM
The adjustable interest rates on ARMs often have rate caps to limit how much a rate can go up after the fixed-rate period is over. Even still, the fluctuation can still harm your financial stability. So if you are looking to refinance into another loan with a better rate and stable payments, there are plenty of options to consider.
Be sure to shop around and compare rates and programs because you don't have to go to the same lender to refinance into a fixed-rate mortgage. As with any other refinance, you will need to apply for the loan and run a credit check to verify your credit score, history, and debt-to-income ratio. You'll also need to submit tax documents, W-2s, bank statements, and pay stubs to qualify.
The loan you refinance to depends on your goals and should be considered carefully. Explore your options and talk with a salary-based mortgage consultant to gain further clarity and insight. When it comes to your future and your finances, it's never a bad thing to get a second opinion.
Pay off the loan sooner
If your goal is to pay off your loan sooner and own your home outright, you may want to consider refinancing from a 30-year mortgage into a 15-year mortgage. Shortening your term may not help you save money every month, but you will save on interest over the life of your loan.
Lower your interest rate
If interest rates are steadily rising and you're closing in on the expiration of your introductory rate of the ARM, you should consider refinancing. Remember, you can refinance more than once. So if rates end up going down in the future, you are able to refinance into a lower rate.
It's impossible to predict what rates will be from year-to-year. So even if you refinance into a rate that isn't lower than your introductory rate was, you are still ensuring that when rates continue to rise, you have locked into a lower rate before the ARM readjusts to an even higher one.
Achieve stability
Locking into a fixed-rate means that your payments will remain predictable in the future. Suppose the introductory rate comes to an end, and you allow your loan to continue into the adjustable-rate territory. In that case, you run the risk of your payments ballooning to unmanageable levels if your budget can't handle such increases.
Take the hassle out of your rate schedule and refinance into a term with a rate and payment schedule that you feel confident that you can handle for the foreseeable future.
When it makes sense to refinance into an ARM
If you don't plan to remain in your home long term, refinancing into an ARM loan might be an option. By refinancing into an ARM, you could take advantage of the low interest rates for those few years. As long as you plan to move before the initial fixed-rate period shifts into the adjustable-rate period, you have the potential to save quite a bit in the next ten years or less.
With interest rates on the rise, it might be the best move to get the lower interest rates that come with the introductory, fixed-rate period of an ARM. Then, as the initial fixed-rate period nears its end, you can decide whether you want to refinance into a fixed-rate mortgage if interest rates have dropped or remain in your current loan.
Additionally, you may even use an ARM loan as a strategic financial maneuver. If you want to pay down your loan faster, you can use an ARM to access the low interest rate and make extra payments regularly towards the loan's principal balance. This strategy can help you pay off your loan sooner and pay less in the long run on interest fees.
Work with a salary-based mortgage consultant
To avoid some of the pitfalls that can be associated with a refinance, we recommend that you work closely with a salary-based mortgage consultant to have another set of eyes on the bigger picture. Your consultant will be able to calculate your potential savings and help determine if a refinance is in your best interest. Since there are many factors to consider, it will save you time and money in the long run if you seek guidance from an industry expert.
At American Financing, one of our salary-based mortgage consultants will provide you with one-on-one attention, a no-pressure, hassle-free experience. We pride ourselves on customizing a loan program to fit your financial needs and goals. So let us know when you're ready to discuss a refinance and get a free mortgage review in the process.
