If you have an adjustable rate mortgage on your home, here the 5 prudent factors to weigh in on when refinancing to fixed rate loan type….
Duration of Introductory Rate Period
Most adjustable rate mortgages are fixed for first few years in the introductory period, and then become variable for the remainder of the duration of the term. These loan types include 3,5,7 and 10 year fixed rate teaser periods. For example the 5/1 arm presents a fixed rate principal and interest payment on a 30 year amortization for the first 60 months of the loan. After month five, the loan becomes adjustable based on an index and a margin. If you have little time left on your loan say one to two years, there could be a case to be made; moving into something in fixed rate category could be a better move, considering 30 year rates are hovering in the 4% range. The longer introductory period you have remaining, the less motivation you might have to refinance, as “riding it out” may be more optimal if you are undecided. However, it is the unknown that you are basing the largest liability of your life on. A big gamble indeed if you have any remote apprehension about the future of your loan payment.
How bad could it get? Most people who have adjustable-rate mortgages typically, only need the money for a short period of time because they are selling the property for example or their financial circumstances are going to change so it doesn’t really matter their loan is going to be adjusting if they’re never going to be in the loan to see it just adjust anyway. Life doesn’t always go according to plan. When the loan is set to adjust you should be asking yourself “can I handle this?” Refer to the terms of your original note; you know the papers that you signed at closing table eons ago. They will have the introductory teaser period, the index (variable rate component), the margin (lender’s profit), along the initial, annual, and life caps on the loan, which will spell out how much the interest rate can change.
Do you plan to keep the property before the adjustment occurs? Or is the plan to sell the property or refinance where you would be exposed to little or no changes in the interest rate and subsequent payment change? If you don’t know how long you’re going to hold the property for and the unknown of the future rates keeps you up at night, refinance. For example if you have three years left on your 5/1 ARM and you know your property is going to be sold in the next one to two years refinancing may not pencil on primary home. One caveat to this may be if the property in question is a rental property. Moving to a fixed rate loan on the rental could be a more favorable approach if you intend keeping the property or have to get a certain price on the market in order to justify offloading the property. A 30 year fixed rate loan is significantly easier to project cash flows around from a net cost perspective than a potentially changing loan payment down the line.
Your loan balance at the time your loan adjusts could be minimal if you have low loan balance on your home. For example if you owe something like $150,000 on your house and your loan payment adjusts, that type of scenario is far different than a loan size at $400,000 adjusting, all other things equal. Another important factor to consider is your income. If your income has risen, since you took out your adjustable rate loan, and you can handle a larger mortgage payment, it always considered a smart move to take extra money and prepay your principal balance. Doing this will benefit you in a few ways:
- If you do refinance in the future, you will be borrowing less, a nice hedge against higher rates should longer-term rates be higher
- Prepaying your current mortgage reduces the amount of interest you’ll pay over time.
Generally, refinancing from an adjustable rate loan to a fixed rate loan is considered a safe bet. Your scenario and financial goals should be the best guide in helping you determine what’s in your best interests. Considering locking in a long term loan? Need guidance with the scenario? Start by getting a free custom mortgage rate quote online now!