Home > Mortgages > Is It Time to Refinance Your Adjustable-Rate Mortgage?

Comments 0 Comments

variable- or adjustable-rate mortgage is a loan where the interest rate is subject to change according to market fluctuations and terms. (A fixed-rate mortgage, on the other hand, offers flat payments throughout the term of the loan.)

Given the Federal Reserve’s recent decision to raise interest rates, some consumers with ARMs may be thinking about refinancing. Here are four prudent factors to weigh if you’re considering a move to a fixed-rate loan.

1. The Duration of Your Introductory Rate 

Most adjustable-rate mortgages are fixed for the first few years in the introductory period, and then become variable for the remainder of the loan term. Loan types generally include fixed-rate teaser periods of 3, 5, 7 and 10 years.  For example, an ARM with a five-year fixed rate has a fixed-rate principal and interest payment on a 30-year amortization for the first 60 months of the loan. After that, the loan becomes adjustable based on an index and a margin.

If you have little time left on your loan’s introductory period (say one to two years), moving into a fixed-rate loan could be a favorable move, considering 30-year rates are currently hovering in the 4% range. The longer introductory period you have remaining, the less motivation you might have to refinance, as “riding it out” may be more optimal for the undecided. However, you are basing the largest liability of your life on the unknown — a big gamble indeed if you have any remote apprehension about the future of your loan payment.

2. The Size of Your Adjusted Payment

Most people who have adjustable-rate mortgages typically only need the money for a short period of time. They may be selling the property, for example, or their financial circumstances may face an imminent change. In these cases, it doesn’t really matter if the loan is going to be adjusting since the borrower may not have the loan long enough to weather the adjustment anyway.

But life doesn’t always go according to plan. If the loan is going to adjust, you should be asking yourself, “Can I handle this?” You can determine affordability by referring to the terms of your original note (the papers that you signed at closing table). This paperwork will have the introductory teaser period, the index (variable-rate component), and the margin (lender’s profit) on the loan, which will spell out how much the interest rate can change.

3. How Long You Plan to Hold the Property

Do you plan to keep the property before the adjustment occurs? Or is the plan to sell the property or refinance where you would be exposed to little or no changes in the interest rate and subsequent payment change? If you don’t know how long you’re going to hold the property for and the unknown of the future rates keeps you up at night, it’s in your best interest to refinance. On the other hand, if you have three years left on your 5/1 ARM and you know your property is going to be sold in the next one to two years, refinancing may not be necessary.

One caveat is if the property in question is a rental property. Moving to a fixed-rate loan on the rental could be a more favorable approach if you intend on keeping the property or have to get a certain price on the market in order to justify selling it. A 30-year fixed-rate loan is significantly easier to project cash flows around than a potentially changing loan payment down the line.

4. Your Current Loan Balance 

Your loan balance at the time your loan adjusts could be minimal. For example, if you owe something like $150,000 on your house and your loan payment adjusts, that type of scenario is far different than a loan size at $400,000 adjusting, all other things equal. Another important factor to consider is your income. If your income has risen since you took out your adjustable-rate loan, and you can handle a larger mortgage payment in the introductoryperiod, it’s almost always considered a smart move to take extra money and prepay your principal balance. Doing so on an adjustable-rate loan will benefit you in a few ways:

  • If you do refinance in the future, you will be borrowing less, a nice hedge against higher rates should longer-term rates be higher.
  • Prepaying your current mortgage reduces the amount of interest you’ll pay over time.

Keep in mind, the interest rates you are offered will vary, depending on how good your credit score is. You can check your credit by viewing your free credit report summary, updated every 14 days, on Credit.com.

Generally, refinancing from an adjustable-rate loan to a fixed-rate loan is considered a safe bet. Your scenario and financial goals should be the best guide in helping you determine what’s in your best interests.

More on Mortgages & Homebuying:

Image: monkeybusinessimages

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team