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When to Refinance From an Adjustable-Rate to a Fixed-Rate Mortgage

March 10, 2015
Banking
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Unlike diamonds, mortgages are not forever. The ultimate goal is to pay them off and own your home free of encumbrances. But there are many good reasons to trade in your original mortgage for a new one along the way.

One of the most common reasons to refinance is to move from an adjustable-rate mortgage, or ARM, to a fixed-rate loan. With an ARM, your interest rate, and therefore your payment, can go up and down. On a fixed-rate mortgage, by contrast, your rate and your payment stay the same for the life of the loan.

It sounds simple, but many homeowners agonize over when to refinance. There are usually fees involved, so it’s important to weigh them against the money you’d save by locking in your interest rate. And realize that if you’re starting over with a new 30-year loan, you may be delaying the date when your loan will be paid off.

Here are some reasons to get on the refinancing bandwagon.

Your rate may adjust upward

Most ARMs are hybrids that begin with a low introductory rate that’s fixed for a certain period of time, after which the rate can move up or down according to a market indicator. If you’re coming up on the end of the fixed-rate period, you may want to avoid the risk of a rate that can vary by securing one that’s fixed for the life of the loan. Try using an online mortgage calculator to figure out how much your payments will be based on today’s rates and your loan balance.

Interest rates may rise

Locking in the same interest rate for 30 years (the length of most mortgages) can be a great move, but only if you get a low, affordable rate. Interest rates are established by market conditions out of your control. Even if you’re doing everything right by paying your bills on time and keeping your debt levels manageable, you may not be able to get a rate as low as you would like. If you think interest rates are likely to rise in the near future, it may be a good time to pin down a rate that will carry you through until your home is paid off.

You can get rid of PMI

Private mortgage insurance, or PMI, is a monthly charge added to your payment by most lenders if you buy with a down payment below 20%. If the value of your home has gone up since you bought it, you might be able get rid of PMI even sooner. If you have a mortgage backed by the Federal Housing Administration and your equity has reached the 20% threshold, you may also save by refinancing as FHA loans include an insurance cost.

You can shorten the loan term

Although 30 years is the standard, there are often 15-, 20- and 25-year mortgages available. If you can afford the higher payments of a shorter term, you can save significantly on interest costs. If you’ve been paying down a mortgage for more than several years, keep in mind that you may have already paid a significant portion of the interest costs of a fixed-rate loan, as interest typically accounts for the lion’s share of each monthly payment for the first 15 years.

The bottom line

Refinancing from an ARM to a fixed-rate mortgage may be in your best interest, as long as you take current market conditions and fees into consideration. Even if it costs you a little more in the short term, having a locked-in interest rate and mortgage payment may make it worthwhile to refinance.