Should You Refinance With An Adjustable Rate Mortgage
Have you refinanced your mortgage yet? And I know this sounds like a commercial, but you are likely missing out on some savings if you havent looked at refinancing options.
With rates at historic lows, many homeowners already cashed in by refinancing in the last couple of months. In fact, the mortgage lender I worked with a couple of months ago told me that hes been in the business for a few decades and hes never seen the amount of volume they were pushing through.
And I believe him, because we were exchanging emails and phone calls all hours of the day, seven days a week. Hes been working nonstop, and likely raking in the cash.
Luckily, we can join in on his party if we can get a better rate on our mortgages. And while you are thinking about loan options, ask the lender whether adjustable-rate mortgages makes sense for your situation.
/1 Arm Rate Stays Put
The average rate on a 5/1 ARM is 2.74 percent, unchanged since the same time last week.
Video: Refinance demand drops as mortgage rates rise
Adjustable-rate mortgages, or ARMs, are mortgage terms that come with a floating interest rate. To put it another way, the interest rate can change intermittently throughout the life of the loan, unlike fixed-rate loans. These types of loans are best for people who expect to refinance or sell before the first or second adjustment. Rates could be substantially higher when the loan first adjusts, and thereafter.
Monthly payments on a 5/1 ARM at 2.74 percent would cost about $402 for each $100,000 borrowed over the initial five years, but could ratchet higher by hundreds of dollars afterward, depending on the loans terms.
Refinancing To A Fixed
Refinancing can be done for many reasons, but switching from an adjustable-rate mortgage to a fixed-rate mortgage is one of the most common.
The general rule of thumb is that refinancing to a fixed-rate loan makes the most sense when interest rates are low. While no one can predict whether rates will go up or down in the future, many homeowners are currently taking advantage of todays low rates to refinance from their adjustable-rate mortgage to a new fixed-rate mortgage. If youre among those who are considering this move, here are some points to be aware of.
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The Interest Savings Arent Worth It
The cost of refinancing can offset any savings you stand to gain by reducing your interest rate and your payment temporarily.
Closing costs like the application and origination fees, appraisal, title search, and title insurance can add as much as 5% to the amount youre refinancing.
In this scenario, youd only reduce your monthly payment by about $5 during the five year initial fixed interest rate period of your loan, after which the rate and payment will begin to vary, which is probably not enough to warrant adding to your debt.
No Private Mortgage Insurance Required For Most Loans
Most lenders require the borrower to purchase PMI unless they’re able to make a down payment of 20%. Most of our Adjustable-Rate Mortgages dont require PMI, which saves you money each month.
Adjustable Rate Mortgages are variable, and your Annual Percentage Rate may increase after the original fixed-rate period. The First Adjusted Payments displayed are based on the current Constant Maturity Treasury index, plus the margin as of the stated effective date rounded to nearest 1/8th of one percent. All loans subject to credit approval.
This rate offer is effective 11/10/2021 and subject to change. Rates displayed are the “as low as” rates for purchase loans and refinances. Rates are based on creditworthiness, loan-to-value , occupancy and loan purpose, so your rate and terms may differ. All loans subject to credit approval. Rates quoted require a loan origination fee of 1.00%, which may be waived for a 0.25% increase in interest rate. Many of these programs carry discount points, which may impact your rate.
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What Is An Adjustable Rate Mortgage
An adjustable-rate mortgage, or ARM for short, is a 30-year loan with a variable rate after a certain amount of time passes. The most popular type of ARM is a 5/1 ARM, which simply means that the rate is locked for five years, after which the rate could change once a year for the rest of the 25-year term.
Another version, the 10/1 ARM, locks your rate for ten years and then adjusts once a year afterward until the loan is paid.
The most popular ARMs adjust the interest rate annually but others, such as the 5/5 ARM, exist in the marketplace as well. As the name suggests, the interest rate adjustment occurs every five years instead of once a year after the initial lock period.
When Is An Adjustable
Adjustable-Rate Mortgages begin with a fixed interest rate and then adjust up or down after the initial term. ARMs are a good option for buyers who dont plan to stay in their home for more than 5 years and want to keep their monthly payment low.
ARM products contain 2 numbers:
- The first refers to the number of years the interest rate will remain fixed.
- The second is the number of years between interest rate changes after the initial fixed term expires.
For example, a 5/5 ARM would have the same interest rate for the first 5 years, and then the rate would adjust every 5 years after that.
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How To Use A Refinance Calculator
There are many free refinance calculators readily available online which can help you determine if refinancing will save you money. With a refinance calculator, you can enter your current mortgage terms, the new proposed mortgage terms and any fees for refinancing. You can try this refinance calculator at LendingTree to see how it works.
A refinance calculator will help you figure out how much money youll save on a monthly basis and over the life of your loan, and whether its worth the costs of acquiring a new mortgage.
Pros Of An Arm Refinance
There are certain situations in which it definitely makes sense to consider refinancing into an ARM. Lets run through a couple of them.
- You dont plan on staying in your home long-term. If you only plan on staying in your home a few more years, you can get a lower rate than current fixed rates with an ARM and move out before the rate ever adjusts. The longest fixed period is typically 10 years.
- You really plan on paying down your balance. Some people use an ARM as a financial hack. Knowing that they can get a lower rate for the first several years of their loan, theyll make regular extra payments toward their principal so that they can really pay down their mortgage. This has the effect that by the time your rate adjusts, or you refinance, youll have a much lower payment even if you havent paid it off because your balance will be smaller.
- Interest rates are running higher. When interest rates are running on the high side, getting into an ARM may make more sense because youre getting an interest rate lower than current fixed rates for the first part of the loan.
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Old Faithful: The Fixed
A fixed-rate mortgage is what most people think of when they imagine how to finance a home purchase. When youget a fixed-rate mortgage, youll commit to a single interest rate for the life of the loan. That rate depends on market interest rates, on your credit score and on your down payment.
If interest rates are high when you get your mortgage, your monthly payments will be high too because youre locked in to the fixed rate. And if interest rates later go down youll have torefinance your mortgage in order to take advantage of the lower rates. To refinance, youll have to go through the hassle of putting together your paperwork, applying for a mortgage and paying for closing costs all over again.
The big draw of the fixed-rate mortgage, though, is that it gives the homebuyer some certainty in an uncertain world. Lots of things can happen over the life of your mortgage: job loss, uninsured illness, tax increases, etc. But with a fixed-rate mortgage, you can be sure that a hike in the interest you pay each month wont be one of those financial snags.
With a fixed-rate mortgage, the lender bears the risk that interest rates will go up and theyll miss out on the chance to charge you more each month. If rates go up, theres no way they can increase your payments and you can rest easy. In other words, the fixed-rate mortgage is the dependable option.
Your Income Is Unpredictable
Theres no telling which way interest rates will go over the long term. If they go up, so might your payment, which can be especially difficult for the self-employed and others whose income fluctuates.
Also, if youre on a fixed income that will most likely not be increasing, an ARM might not be a good idea. This is because you might not be able to handle the rate or payment increases after the introductory period is over.
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The Differences Between An Arm And A Fixed Rate Mortgage
An adjustable-rate mortgage is a mortgage where the interest rate varies throughout the life of the loan. Many ARMs have an introductory rate that is set for a period of time and then may change. One popular adjustable rate mortgage is the 5/1 ARM loan which means the interest rate stays the same for the first five years of the loan and afterwards may adjust once a year. With a fixed rate mortgage, the interest rate stays the same throughout the life of the loan.
Some homebuyers choose adjustable rate mortgages because the starting interest rate can be lower than the interest rate on fixed rate mortgages. If you are planning to own a house for a shorter period of time, you might choose an ARM to take advantage of the lower monthly interest payment. For example, if you are planning to own a home for five years, you might choose a 5/1 ARM because you intend to sell the house before the interest rate adjusts.
Does Refinancing From An Arm To A Fixed
That depends on many things, including the terms of your current loan, whether interest rates move up or down, and how long you plan to live in your home. Many homeowners refinance an ARM to a fixed rate mortgage when rates are low so they can “lock in” savings on interest payments. These homeowners may believe that interest rates are likely to rise in the future and by refinancing from an ARM to a fixed rate mortgage they will protect themselves from higher interest rates down the road.
Keep in mind that when you refinance an ARM, you may need to pay closing costs. Financial professionals often recommend you balance the closing costs of a refinance against the savings a new loan might offer. Many times they will recommend you calculate a “break even” point, which is the month in the future when the cost of refinancing is balanced by the savings.
Say for example you refinance your 5/1 ARM mortgage, pay $1,200 in closing costs, and save $100 a month when compared to the monthly payment on your previous mortgage. In this case, you will break even after one year . Starting in the second year of the new loan, you will save $100 a month and the longer you live in the house the more you might save. Try our home refinance calculator which includes a break-even analysis to estimate your savings. By refinancing, the total finance charges may be higher over the life of the loan.
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It’s A Better Match For The Average Length Of Homeownership
Too many people overestimate how long they’re going to live in and own the same home. Given that the average homeownership tenure is 8.5 years, it makes no sense to do a 30-year fixed rate.
The more efficient route would be to do an ARM that matches a reasonable homeownership period. For example, if you plan to live in your house for eight to 10 years, taking out a 10/1 ARM is more cost-effective.
A 10/1 ARM is usually between 0.25% to 0.5% less expensive than a 30-year fixed-rate mortgage. Why? Because rates are lower when you borrow for a shorter period of time.
To illustrate, let’s compare a 10/1 ARM with a 2.5% interest rate versus a 30-year fixed mortgage with a 3% interest rate.
With the 10/1 ARM, the borrower’s monthly payment is $133 less, and after 10 years, the balance declines by 26% . If the mortgage isn’t paid off or if the house isn’t sold by the 10th year, the owner can either refinance for a balance lower than 26% or let the ARM float.
Different Types Of Adjustable
Lenders can structure ARM loans in several ways, as long as they meet federal lending laws. The result is a variety of adjustable-rate mortgages. Examples of ARMs currently available include:
- The 7/1 ARM. The interest rate is fixed for the first seven years. It adjusts each year after that, starting with year eight.
- The 5/1 ARM. The interest rate is fixed for the first five years. It adjusts each year, starting with year six.
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Refinance Your Arm To Another Arm
Before you refinance your ARM, you need to know a couple of things:
- How long do you expect to keep your loan now?
- What are your ARM interest rate and payment likely to be?
- Will you save money by refinancing?
- Can you sleep at night without a fixed loan?
If the answer to the last question is a resounding no, get yourself to a lender and get yourself a fixed-rate refinance.
End of story.
However, if you expect to have your home and your mortgage for just a few years more, you may save a ton, again, with a new 3/1, 5/1, 7/1 or 10/1 ARM.
Your first step is determining what would happen to your ARM if it were adjusting today, and what its likely to do in the near future.
To do this, you need to look at your loan paperwork and find your loans index, margin and caps.
Suppose you have an ARM with a two-percent-per-year cap, a 2.25 percent margin and a five percent lifetime cap. Todays LIBOR index is near 2.8% percent, so if your loan were resetting today, your new rate would be 5.05 percent. If your current rate is 3.0 percent, your increase is only 2.00 percent . That new 5.0% rate is good for another year.
But what about subsequent years? Here are a few more figures for you.
Right now, ARMs just dont look that scary.
Which Loan Is Right For You
When choosing a mortgage, you need to consider a wide range of personal factors and balance them with the economic realities of an ever-changing marketplace. Individuals personal finances often experience periods of advance and decline, interest rates rise and fall, and the strength of the economy waxes and wanes. To put your loan selection into the context of these factors, consider the following questions:
- How large a mortgage payment can you afford today?
- Could you still afford an ARM if interest rates rise?
- How long do you intend to live on the property?
- In what direction are interest rates heading, and do you anticipate that trend to continue?
If you are considering an ARM, you should run the numbers to determine the worst-case scenario. If you can still afford it if the mortgage resets to the maximum cap in the future, an ARM will save you money every month. Ideally, you should use the savings compared to a fixed-rate mortgage to make extra principal payments each month, so that the total loan is smaller when the reset occurs, further lowering costs.
If interest rates are high and expected to fall, an ARM will ensure that you get to take advantage of the drop, as youre not locked into a particular rate. If interest rates are climbing or a steady, predictable payment is important to you, a fixed-rate mortgage may be the way to go.
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Adjustable Rate Loan Options
FHA ARM, Jumbo ARM, and VA ARM loans feature an initial fixed rate period, after which the rate adjusts. All Adjustable Rate Mortgages adjust based on predetermined guidelines.
We offer a variety of terms:
- 5 Year ARM – offers an initial fixed period of 5 years, then the rate adjusts. The 5 Year ARM is an option for FHA, VA, Conventional, and Jumbo loans.
- 7 Year ARM – offers an initial fixed period of 7 years, then the rate adjusts. The 7 Year ARM is an option for Conventional and Jumbo loans.
- 10 Year ARM – offers an initial fixed period of 10 years, then the rate adjusts. The 10 Year ARM is an option for Conventional and Jumbo loans.
How Are Adjustable Rate Mortgage Rates Determined
ARMs start out with a fixed-rate period, often one, three, five, seven or 10 years. During this initial loan period, the ARM is essentially a short-term fixed-rate loan. ARMs with longer fixed-rate periods typically have slightly higher mortgage rates,notes Gumbinger.
After the fixed period, the mortgage rate adjusts according to the loan terms. In the case of a 5/1, the ARM can reset every year following the five year fixed-rate term. One of the major determinants to the adjusted interest rate is the index to which the mortgage is linked.
For example, if at the time of adjustment, the index interest rate is 4% and your margin is 2%, the lender adds them together to arrive at a 6% interest rate for your loan.
“Most ARMs are adjusted according to the LIBOR index, a market interest rate which is based on the global economy, and some are adjusted according to Treasury securities, which are more closely tied to Federal Reserve decisions,” explains Gumbinger. “Studies have shown that both of these indexes end up in about the same place over time, but borrowers should ask about the index and understand how it works.”
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