Written by David McMillin
- Oct. 4, 2021
- 5 min read
Suzanne De Vita
Robert R. Johnson
If you’re nearing the end of the initial term on your adjustable-rate mortgage (ARM), you might be wondering if now is a good time to refinance, and whether you should switch to a fixed rate.
Despite low mortgage rates, the majority of homeowners haven’t refinanced, according to a recent Bankrate survey, with many worrying that they might not save enough to justify the cost. Still, with some ARMs having high caps on rate increases, the stability of a fixed monthly payment can make refinancing worth it.
“The idea of trading away the uncertainty of an adjustable-rate mortgage for the certainty of a fixed-rate mortgage is appealing, especially if you’re expecting an adjustment in the next year or two,” explains Greg McBride, CFA, chief financial analyst for Bankrate.
Can you refinance an ARM?
Like many types of loans, you can refinance an ARM. When you refinance an ARM, you replace your existing loan with a brand new one. In simplest terms, you’ll go through the preapproval and underwriting process with a mortgage lender — it could be your current lender or a different one — as well as the appraisal process to determine your home’s value. Once all the paperwork is complete, you’ll hand over a check for the closing costs, and you’ll have a new mortgage with new terms.
Is now a good time to refinance an ARM?
Overall, now is a great time to refinance due to low mortgage rates, but the ideal timing for you depends on your financial goals and longer-term plans, and whether you can afford the closing costs. Here are a few considerations to make:
How is your credit?
Refinancing isn’t an automatic money-saver. You need to have strong credit to qualify for the lowest rate and the biggest savings opportunity. If you’ve been making timely payments on your ARM, that should be helping elevate your credit score.
“Someone coming up on the end of an ARM presumably has five or more years of timely mortgage payments on their credit history,” explains Austin Kilgore, director of Digital Lending at Javelin Strategy & Research. “There’s a good chance their credit score is better now and they may qualify for something better.”
If your credit could use some work, however, it’s best to wait to refinance until you’ve improved your score. Check your credit report for any errors, such as incorrect contact information — and if something’s amiss, contact the credit reporting agency as soon as possible to get it fixed. If you can, pay down or pay off other debt, and continue to make credit card and other loan payments on time each month.
What are your goals?
In addition to locking in a low rate, think about any other goals refinancing can help you achieve, such as paying off your mortgage sooner, doing a cash-out refinance or consolidating debt. While a cash-out refinance increases the amount you owe, you’ll be able to use the funds for home improvements or other expenses or goals.
Keep in mind, too, that you aren’t the only one thinking about refinancing these days. Refinances accounted for 66 percent of applications recently, according to the Mortgage Bankers Association, and as of July 2021, the average time to close a refinance was 47 days, according to ICE Mortgage Technology. If your lender is swamped with other applications, the process could take longer than you expect, which could factor into your decision.
How long are you planning to stay in your home?
If you have no intention of moving or selling your home anytime soon, refinancing into a fixed-rate mortgage can be a smart decision. If a move is on your near-term horizon, however, it’s likely not worth the cost to refinance.
For example, if you’d save $100 on your monthly mortgage payment by refinancing, and the closing costs are $2,000, it’d take you 20 months, or close to two years, before you really start to see savings. Bankrate’s mortgage refinance break-even calculator can help you run the numbers for your situation.
“If you’re only looking at being at home for three or four more years and you have four years before it resets, and a new loan is not at least three-eighths of a basis point lower than your current rate, you might as well stay in your ARM,” advises Ralph DiBugnara, founder of Home Qualified, a digital resource for homebuyers and sellers. “There’s no financial benefit to move forward into a fixed rate.”
Should I refinance my ARM to a fixed rate?
At the very least, you should think about refinancing your ARM to a fixed rate if current mortgage rates are lower than the rate you’re paying and you’re nearing the end of the initial term on your ARM. The rate isn’t the only piece of the puzzle, however. Consider the following:
How much could you pay when your ARM resets?
Take a look at your paperwork — or reach out to the mortgage servicer that processes your payments — to understand the annual cap and the lifetime cap on your ARM. The annual cap will give you an idea of how much the rate could increase when it resets, and the lifetime cap is the maximum allowed for the entire duration of the loan.
Are you paying off an interest-only ARM?
If your ARM included an interest-only introductory period, you’ve only needed to pay the interest, not the principal. While you’ve been benefiting from low payments, you haven’t been building any equity in your home, so you’ll be in for a surprise when you have to pay down the actual loan. In this case, refinancing to a fixed-rate option can be an especially smart move.
Benefits of a fixed-rate mortgage
If you’ve never had a fixed-rate mortgage, here are the key upsides of this type of loan:
- Your payments are always the same. A fixed-rate mortgage gives you the certainty of predictable payments. Rather than wondering how the market will impact your payments on an ARM, a fixed-rate option never changes for the entire loan term.
- You can budget more easily. With a fixed-rate loan, you can plan for a stable housing payment.
- You still have options. If a 30-year mortgage sounds like a lifetime, you can also look at a 15-year fixed-rate mortgage. The rates on this type of loan are even lower, but the tradeoff is that you’ll have higher monthly payments due to the accelerated timeline.
What about refinancing an ARM to another ARM?
Refinancing doesn’t have to involve switching to a fixed-rate mortgage — you could refinance your existing ARM to a new ARM.
Just because you can doesn’t mean you should, though. In today’s low-rate environment, you could be paying more with an ARM, so it’s imperative to compare current rates on both ARMs and fixed-rate options.
Current mortgage rates
The average 30-year fixed refinance rate is currently 3.200%, according to Bankrate’s national survey of mortgage lenders, and the average 15-year fixed refinance rate is 2.550%. By comparison, the average 5/1 ARM refinance rate is currently 3.990%.
It is still one of the least expensive times in history to borrow money for a home, but it can’t last forever. With the Federal Reserve signaling the potential for an interest rate hike as early as 2022, today’s mortgage rates might be the best you’ll find. In fact, Freddie Mac’s most recent economic outlook predicts 30-year mortgage rates to hit 3.8 percent by the end of next year. So, if you’re thinking about refinancing, avoid the waiting game. Even if you’ve already refinanced your mortgage, it might actually be worth doing again.
When looking to refinance, it’s important to shop around for a lender, even if you’ve established a relationship with the one you currently have. Compare the fees and terms in order to see how much you’d truly be saving across different lenders. You might also consider consulting with a mortgage broker. Some have relationships with specific lenders and can offer rates you might not get directly from those lenders.