Should I Convert My ARM to a Fixed Loan?
Lenders offer adjustable rate mortgages (ARMs) at lower starting interest rates than comparable fixed loans in return for the borrower taking on more risk. They come in many flavors. Some hybrid loans offer fixed rates for 2 to 5 years and convert to variable loans after that. Borrowers in these variable loans should consider refinancing into a fixed rate mortgage if they feel interest rates may be rising in the future or their tolerance or capacity for risk changes.
What questions do you need to answer in order to make a smart decision about refinancing into a fixed loan? First, make sure you know your current loan inside and out. Here are some of the questions that you need to be able to answer:
- Is there a floor (minimun) rate for my loan? Credit challenged borrowers may have loans where the interest rate can never go below the starting rate.
- When is the first interest rate adjustment going to be made?
- What is the maximum amount the rate can increase at the first adjustment?
- How frequently will the rates be adjusted after the first increase?
- What is the maximum amount the rate can increase at each additional adjustment?
- What is the overall lifetime cap for interest rates increase on the loan?
- Does my loan have a prepayment penalty and, if so, when does it expire and how much would it be if I refinanced now? Credit challenged borrowers in some states may have loans with prepayment penalities.
- How long do I plan to keep the home?
Now look at the worst case for your loan. Assume interest rates rise at the maximum amount for each adjustment. Are you likely to be able afford the maximum payment? If you are likely to sell your home, focus your attention on that time period.
Go ahead and get a quote for a fixed loan. If you have a prepayment penalty, be sure that paying it off is factored into the new loan amount. If you're prepayment penalty is about to expire, it often makes great sense to wait to complete the refinance.
Use our adjustable rate and fixed rate mortgage calculators to compare the best and worst case scenarios for interest rate changes on your current loan versus the fixed loan and you should be on the road to making a sound decision.
