Refinancing Your ARM Into A Fixed-Rate Mortgage

If you’re nearing the end of the first term of your adjustable rate mortgage (ARM), you might be wondering if now is a good time to refinance to a fixed rate. Let’s take a closer look at how to refinance an ARM and when it’s a good time to refinance to a fixed rate.

Can I refinance my ARM loan?

Refinancing an ARM loan allows you to replace your existing mortgage with a new mortgage, which can be either another ARM or a fixed-rate mortgage.

With ARMs, many people choose to refinance because interest rates are rising. It’s important to remember that refinancing isn’t free; you’ll still have to pay closing costs. So even if your interest rate is much lower after refinancing, it’s wise to calculate your breakeven point to determine when you’ll start saving money.

Keep in mind that when you refinance your adjustable rate mortgage, you have a choice of lenders. This can be your current lender or a different lender, depending on which institution can offer you the best rates, services, and terms.

How to Refinance an ARM

Refinancing an ARM is very similar to refinancing a fixed-rate mortgage. Before you begin the process, make sure you meet the requirements. To qualify for a conventional mortgage, you usually need a credit score of at least 620, a debt-to-income ratio (DTI) of 50 percent or less, and at least 20 percent equity (though some lenders might accept a lower ratio). You may also need to have owned your home for at least six months.

If you meet these requirements, follow these steps to refinance your ARM.

1. Get quotes and compare: Don’t just assume you’ll refinance with your current lender — shop around and get quotes on interest rates, fees and terms from multiple lenders to compare and find the best offer.
2. Choose a lender and apply: Gather all your financial documents and submit them to your chosen lender.
3. Evaluation schedule: Most mortgage refinances require an appraisal, which the lender will order and the borrower will have to pay for.
4. The loan will be completed after undergoing screening. Just like when you applied for your first mortgage, you’ll need to work with an underwriter to review your financials. Once everything is in order, you’ll sign the documents and set a settlement date when you’ll pay your closing costs. Note: You can pay your closing costs up front or roll them into the loan.

Costs of refinancing an ARM

Remember: Refinancing isn’t free. Be sure to understand the costs of refinancing your mortgage before switching from an adjustable-rate loan to a fixed-rate loan. You’ll need to factor a variety of costs into your budget, including origination fees, appraisal fees, and title services.

On the plus side, refinancing costs are often much lower than the closing costs of a home purchase loan. The exact amount depends on the loan amount and where you live, but generally these costs will be between 2 percent and 5 percent of the loan amount. For example, if your new loan balance is $250,000, you could pay between $5,000 and $12,500 in closing costs.

Because a refinance is essentially a new mortgage, your closing costs will be roughly the same as those for a purchase loan — you might be able to skip some (you probably won’t need a home inspection) — but fees are often a percentage of the principal, and you’ll receive less money overall (probably because you’re paying down part of your mortgage).

Benefits of refinancing an adjustable rate mortgage to a fixed rate mortgage

ARMs are more complicated than fixed-rate mortgages. A fixed-rate mortgage maintains the same mortgage interest rate throughout the life of the loan (usually 15 or 30 years). In contrast, an ARM is a 30-year loan with a fixed interest rate for the introductory period (usually 3 to 10 years). After this period, your interest rate adjusts every 6 months or yearly based on a specific market index.

There are benefits to refinancing an ARM to a fixed-rate mortgage: ARMs initially offer a lower interest rate than fixed-rate loans, but once that introductory rate ends, your payments could increase significantly.

Here are the main benefits of refinancing your ARM to a fixed-rate mortgage:

• Your payment will always be the same: A fixed-rate mortgage gives you the certainty of predictable payments. You don’t have to worry about how market or economic trends might affect your variable interest rate and therefore your monthly payment, and your bills will stay the same over the life of your loan.
• Making budgeting easier: With a fixed-rate loan, a stable amount of money dedicated to your major housing expenses allows you to more effectively budget for the other expenses in your life, not just now but into the future.
• You still have options: If a 30-year mortgage seems like a lifetime commitment, you could also consider a 15-year fixed-rate mortgage. The interest rates on this type of loan are even lower than those on a 30-year fixed-rate loan, but the trade-off is that your monthly payments will be higher because of the shorter repayment period.

Disadvantages of Refinancing an ARM

Refinancing an adjustable rate mortgage to a fixed rate mortgage isn’t always the right choice. Here are some potential drawbacks to consider before refinancing:

• You will need to pay the following closing costs: While settlement costs for a refinance are typically lower than a purchase loan, they can still cost thousands of dollars and reduce (or delay) any benefits you expect from the refinance.
• You may lose your savings: If you refinance to a fixed-rate loan and your interest rate drops, you won’t get any of the interest savings you would have gotten with an ARM.
• It could take longer and cost more to pay off your mortgage. Extending your loan term as part of a refinance can increase the interest you pay over the life of your mortgage. It also delays your repayment date.

Should I refinance my adjustable rate mortgage (ARM) to a fixed rate mortgage?

Can you refinance an ARM loan? Absolutely. But should you? Recent increases in mortgage rates may make refinancing less attractive if you took out an ARM loan before the pandemic.

“Borrowers who took out an ARM five years ago could potentially end up with lower monthly payments and less interest for the first year or two after a rate reset than they would if they were to take out a new mortgage at today’s rates,” says Austin Kilgore, an analyst at Achieve’s Consumer Insights Center.

“Interest rates for new adjustable and fixed rate mortgages are significantly higher than they were five years ago, but interest rate resets on existing adjustable rate mortgages are subject to both annual caps (usually 1-2%) and maximum caps over the life of the loan (usually 5-6%),” adds Kilgore.

On the other hand, if your introductory rate is about to end, refinancing may make sense. Current interest rates are much higher than they were, say, five years ago, so a sudden increase in interest rates can come as a shock. If you can secure a fixed-rate loan that is lower than the interest rate your ARM is trying to adjust to, choosing to refinance your ARM to a fixed rate is a smart choice.

How to decide to refinance

So, can you refinance your ARM loan to your financial benefit? To see if that’s true for your specific situation, consider the following:

• Credit score: To get the best rate, you’ll need to have a good credit score. “People who are nearing the end of their ARM likely have five or more years of on-time mortgage payments in their credit history,” Kilgore says. “Your credit score is likely better now, and you may be able to match up with better terms.” But if your score has room for improvement, it’s best to wait.
• Financial Goals: Before you apply, determine your reasons for refinancing — for example, you want to pay off your mortgage faster, make your payments more predictable, or turn some of your equity into cash for home improvements or debt consolidation.
• Long-term plan: The key question is how long you plan to stay in your home before refinancing. “If you only plan to stay in your home for another three or four years, have four years before interest rates reset, and your new loan isn’t at least three-eighths of a basis point lower than your current rate, you’re better off staying on the ARM,” says Ralph DiBugnara, founder of Home Qualified, a digital resource for home buyers and sellers. “There’s no financial advantage to moving to a fixed rate.”
• Ability to cover closing costs: Closing costs for a refinance range from 2 to 5 percent of your mortgage principal. That means for a $300,000 mortgage, you could pay between $6,000 and $15,000 in closing costs. You can also roll these costs into your mortgage with a no-closing-cost refinance, but keep in mind that you’ll still be paying interest.

So, is it even possible to refinance an adjustable-rate loan? Of course you can. But refinancing an adjustable-rate loan only makes sense if it helps you achieve your specific financial goals. Compare rates and crunch the numbers to see if refinancing your adjustable-rate mortgage is right for you. Also, keep an eye on interest rate trends. If percentages are going down, you might be better off sticking with that adjustable-rate loan after all.

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