ARM Wrestling: When You Should Refinance Your Adjustable Rate Mortgage

2003, 2004, 2005… not a bad time to get an adjustable rate mortgage (ARM). For many people, it was the best way to get into a first home. Years of record-low interest rates made ARMs look attractive. ARMS had lower rates than fixed rate mortgages (FRMs), because with an ARM the borrower is at risk instead of the lender. If you have an ARM, you bear the risk of higher interest rates, but this risk has paid off for many home owners whose adjustable rates are typically between .05% and 2% below fixed rate averages.

As of 2006, there are many reasons to consider refinancing your ARM - two trillion reasons, in fact. This is the estimate for ‘reset’, the total dollar value of real estate tied to coming adjustable interest increases in the U.S. in the next 18 months.

ARMs make up a large portion of all home real estate, with an estimated 18% of national home ownership now based on adjustable rates. The first quarter of 2006, in fact, saw 25% of all mortgages established as ARMs. If the prime interest rates go up by 2%, this may mean that ARMs will reset from 30-50% per month. An $800 monthly payment may turn into $1200, for example.

If this possibility becomes a reality, the profit you have been building in your home equity might be reversed unless you refinance your ARM.

Experts generally recommend refinancing when you can save at least $5,000 on the term of your loan. Depending on the type of ARM you have, and how long you intend to stay in your home, you also might need to take steps to limit the costs of closing on a refinance.

In times of an uncertain economy, you always should consider ridding yourself of the risks associated with an existing ARM. You may be able to replace your current ARM with a ‘hybrid’ ARM.

• Consider a 3/1 ARM if you do not plan to stay in your home for more than a few years, and if your current ARM is for a longer period of time.

• If you are refinancing from one ARM to another, shop for a loan without a pre-payment penalty.

Uncertainty about the economy and about interest rates is an unfortunate factor associated with ARMs. Many people do not even know exactly how and when their ARM is scheduled to increase (visit http://www.bankrate.com to see current rates). Homeowners with ARMs should not panic however; they simply should continue to use their homes to make money. After all, an increase in interest rates is going to cause prices to rise all across the economy, and credit cards rates - for example - might be a larger problem than a home mortgage.

It is wise to avoid following conventional wisdom when it comes to ARMs. Because so many people are utilizing variable rate loans, the market will be forced to accommodate to a variety of demands so that individuals can pay their increased rate mortgages. Now might even be a good time to get out of one adjustable rate, and into a different ARM. It also is still possible, given doubt about whether the Federal Reserve is going to raise interest rates in the next quarter, that you can ask for significant savings (think up to 2% below FRMs) if you decide to refinance with another ARM. The truth is that the economy now depends on low interest rates to sustain growth, and experts disagree about whether or not interest rates will rise.

If you do decide to refinance, there are practical considerations about when do so. For example, winters mean slower business for banks, so you usually will get lower loan rates then than in the summertime. You also should be aware of tax time – there are likely to be significant changes in tax deductibility accompanying a change in refinancing.

If you are worried about the future of your ARM, take a deep breath and relax. Not very many people default on their ARMs just because of an increase (or resetting) of the ARM rate, and a refinance might work out perfectly for your situation.