Written by David McMillin
- April 20, 2022
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.
Although mortgage interest rates have risen substantially from the lows reached in 2021, it still might be a good idea to switch to a fixed rate, if only for the stability of a fixed payment.
“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?
Mortgage rates are low by historical standards, but generally increasing, so now may be a good time to refinance before rates climb higher. The ideal timing for you depends on your unique financial situation. You’ll want to consider factors such as:
- 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,” explains Austin Kilgore, director of Corporate Communications at the Freedom Financial Network. “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 38.8 percent of applications recently, according to the Mortgage Bankers Association, and as of April 2022, the average time to close a refinance was 48 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? 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.
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.
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, you’ll need to take a holistic look at your financial situation and consider factors like your credit score, financial goals, and ability to afford closing costs.
