When you are ready to take out a mortgage for your home, the two main options available are an adjustable-rate mortgage (ARM) and a fixed-rate mortgage. Both types of mortgages have their benefits and detractions, but just because one option makes sense when you buy your home, that doesn’t mean it will still be the best option years down the road.
There often becomes a point over the life of an adjustable-rate mortgage that it makes sense to lock in the lowest refinance rate by converting your ARM to a fixed-rate mortgage. In this post, we’ll cover when to refinance your ARM to a fixed-rate mortgage in order to get the most long term value.
When does an adjustable-rate mortgage make sense?
There are specific situations and personality types that find an ARM to be a wiser choice. People who choose an ARM over a fixed-rate mortgage typically have an appetite for higher risk transactions and have confidence that they can manage their interest rate more effectively over the life of the loan than if it was at a fixed rate.
ARMs are also a good option when the homebuyer is positive they’ll only live in their home for a set period of time, and the long term protection of a fixed-rate mortgage isn’t as necessary.
Lastly, if interest rates are low, and predicted to trend downwards, an ARM is a great affordability choice.
When should you refinance your ARM to a fixed-rate mortgage?
If there was ever a pristine opportunity to refinance your ARM to a fixed-rate mortgage, it is right now. Mortgage rates are still being artificially suppressed by global economic events. The 10-year treasury yield—the best barometer for interest rates—is near a record-low rate.
Signals like this show that we are in a fixed-rate market, but also that the rates are likely bottoming out. The interest rates will probably turn upwards in the near future. Therefore, if you are currently holding an ARM, consider refinancing to a fixed-rate mortgage today, before they begin to rise.
Additionally, it’s not necessary for the current fixed rates to be as low as ARMs for a fixed-rate mortgage to make more sense. You must factor in the risk that comes with holding an ARM, and how that risk increases each month you get closer to the end of the ARM’s "unadjusted" period. Every ARM has a specified period where it does not adjust. The unadjusted period can range from one to ten years. For example, "5/1" is an ARM with five years of a non-adjustable rate. During this period, you effectively have a fixed rate.
However, if you're in year four of your 5/1 ARM, it's time to make a decision about what your next step will be for your mortgage. Don’t wait until the last minute.
Should you refinance your ARM to another ARM?
There are only two reasons why you would refinance an ARM to a new ARM.
First, if you have a higher risk appetite, you'll need to refinance your ARM regularly in order to achieve the goal of having your mortgage’s average interest rate fall below what you would have locked in through a fixed-rate mortgage.
Second, the fixed rates are too high in order for there to be any savings by refinancing an ARM to a fixed-rate mortgage. If a homeowner starts out with an ARM and plans to eventually refinance to a fixed-rate mortgage, that decision doesn’t make sense if the current interest rates have dramatically risen. In those situations, homeowners may then be forced to refinance back into another ARM in order to mitigate the problem.
The obvious time to refinance an ARM to an ARM is well before the unadjusted period ends. If you find yourself in a situation where fixed-rate mortgages are significantly higher than ARM rates, you can stretch out your unadjusted period of your new ARM.
In other words, if you’re currently in a 5/1 ARM, try going into a 7/1 or 10/1 ARM so that your fixed-rate period is increased as a result of your refinance. For more information, read what the refinance process looks like.
ARMs and fixed-rate mortgages both offer great benefits, but choosing between the two depends on what you're specifically seeking in your home’s mortgage. When you are considering when to convert your adjustable-rate mortgage to a fixed-rate to a fixed-rate mortgage think about how long you plan to stay in your home
If you are going to be living somewhere short term, an ARM makes sense because you won't need the long term protections that fixed-rate mortgages offer.
However, if you’re living in a home for 5+ years, it’s a great time to convert your ARM to a fixed rate mortgage. The record-low interest rates make converting your ARM to a fixed-rate mortgage an obvious choice.
Contact Homesite Mortgage if you have any question about how you can refinance your home to a lower interest rate.