Lenders offer adjustable rate mortgages (ARMs) at lower starting interest rates than comparable fixed rate mortgages in return for the borrower taking on more risk. They come in many flavors. Some hybrid mortgage loans offer fixed rates for 2 to 5 years and convert to adjustable rates after that. Borrowers in these adjustable rate mortgages 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 rate home loan? First, make sure you know your current mortgage inside and out. Here are some of the questions that you need to be able to answer:
Now look at the worst case for your ARM. 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.