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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.
In general, fixed-rate loans are good when rates are low or on the rise, because they lock in your payment and help you avoid constant rate increases. If rates are dropping, then an ARM lets you benefit from those decreases.
“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,” says Greg McBride, CFA, chief financial analyst for Bankrate.
How to 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.
Lenders typically offer specific mortgage refinancing loans, so you’ll use their refinance application form to apply. Beyond that, the process is similar to your initial mortgage application, except that you already own the home. That can make some things, like inspections and appraisals a bit easier to schedule.
Keep in mind that you can choose the lender for your refinance. it could be your current lender or a different one.
To give yourself a good chance of qualifying for a refinancing loans, try to meet these requirements:
- Own the home for at least six months
- Have at least 20 percent equity
- Have a credit score of at least 620 (for a conventional loan)
- Have a debt-to-income ratio under 50 percent
Also keep in mind that you have to pay closing costs on the new loan, so you’ll want to make sure that you can afford to pay them. Also make sure that refinancing saves you more than it costs.
Benefits of switching to 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.
Is now a good time to refinance an ARM?
Mortgage rates rose significantly in 2022 and are much higher than they were in previous years. That means refinancing to a fixed-rate loan will lock in these high rates.
On the other hand, if your introductory rate is about to end, refinancing might still make sense, especially if you can secure a lower rate on a fixed-rate loan than the rate your ARM is about to adjust to. Another perk is that it gives you predictability despite today’s unpredictable rate environment.
- Credit score: Do you have a strong enough credit score to obtain a competitive interest rate?
- Financial goals: Would rather prioritize another goal such as paying off high-interest debt?
- Longer-term plans: Will you stay in the home long enough for you to exceed the break-even point on your closing costs?
- Ability to afford closing costs: Will the burden of paying closing costs outweigh the benefits of a lower monthly payment?
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,” says Austin Kilgore, director of corporate communications at mortgage firm Achieve. “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 financial goals?
Think about the financial 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.
How long do you plan to stay in the 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 to a fixed rate mortgage?
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 or 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? Make sure you have a clear understanding of 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. Your payments will rise significantly when you have to pay down the actual loan, so it may be smart to refinance to a fixed-rate option.
Another thing to think about is refinancing your ARM to another ARM. This means getting another introductory rate period and kicking the can on truly adjustable rates down the road by a year or two – or five. Compare rates for new ARMs and fixed-rate loans to see if this makes sense.
Bottom line
Refinancing an ARM to a fixed-rate mortgage can be a wise investment in your financial future, potentially saving you thousands in lower monthly mortgage payments over the life of the loan. Not only that, you’ll be spared the uncertainty and stress that may accompany a fluctuating mortgage rate. Before you make your decision, take a holistic look at your financial situation and consider factors like your credit score, financial goals, and ability to afford closing costs.
