Adjustable-rate mortgages have been a favorite funding choice, especially for first-time homebuyers, but the prospect of rising interest rates is causing many borrowers to rethink their home loan strategy.
“Honestly, the last 10 years have been awesome for people on ARMs,” Steve Garrett, a mortgage banker in Kansas City, Missouri, with Armed Forces Bank, tells NerdWallet. “A lot of people have ridden the ARM wave, if you will, for quite a while, and they’ve done well on it. But they know it’s the end of the ride, and it’s time to get serious and get into a fixed rate.”
However, making the switch — refinancing from an ARM to a fixed-rate mortgage — isn’t for everyone. It’s not just about interest rates; you’ll also need to consider your personal circumstances.
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Ask lots of questions when considering a fixed-rate refinance
“Every situation is different,” says John Schleck, senior vice president at Bank of America. “Get professional input; sit down with a loan officer. Go over your entire situation, not just your mortgage situation but really look at all of your finances. When are you thinking about retiring? How long are you going to be in your house? There’s so many questions I think you’ve really got to look at, not just a simple answer to, ‘I’m in an adjustable rate and fixed rates look really good, let me just jump over there.’ ”
Garrett at Armed Forces Bank suggests some additional questions to ask yourself: Is this your forever home, or are you just a few years from an upgrade or a downsize? If you plan to stay in your home for a handful of years or less, the ARM may continue to serve you well, if you can absorb potential interest rate increases.
Your ultimate decision on whether to convert from an ARM to a fixed-rate mortgage will depend on your cash flow needs and your tolerance for interest rate risk, he says.
Look for your ARM reset notice
Garrett says homeowners with adjustable-rate mortgages should be on the lookout for annual reset notices: written notification to borrowers of the date and amount of any change in their interest rate.
“Normally, it’s three to six months before the rate is due to adjust,” Garrett says. “For the last, I would say, 10 years, people with ARMs have benefited greatly because rates across the board on everything have been so stinking low. And so you have people who bought a house six, seven years ago with an adjustable rate and year after year, their rate has actually continually gone down — and their payment has gone down.”
But he says that trend is set to reverse if mortgage rates begin to creep higher.
Pull out your mortgage paperwork
When you’re ready to crunch the numbers to make a decision, Bank of America’s Schleck says the first step is to pull out your home loan paperwork and pay particular attention to the “adjustable rate rider.”
“You probably haven’t looked at it since you closed your loan,” Schleck says. “There are terms and conditions in there that will explain exactly how [your mortgage] works. And most, not all but most, adjustable rates have caps. So they might have a periodic cap or a lifetime cap.”
These caps limit the amount the interest rate can rise each year and over the life of the loan. And most ARMs adjust annually, “So it’s not like you can go from 3% to 10% in one fell swoop,” Garrett adds.
As you review the original loan paperwork, reach out to your loan servicer to get explanations of any loan terms that aren’t completely clear to you.
Resist the temptation to reset to 30 years of payments
Garrett sees a lot of borrowers who move from an ARM to a fixed-rate mortgage opting for a shorter loan payback, especially if they’ve had their loans for “around 10 years, give or take.”
“They either want to stay with a 20-year, for instance, or they’re dropping down to a 15-year, which is smart,” he says. By resisting the temptation to reset their loan back to 30 years even though their monthly payment would be lower, they reduce the amount of interest to be paid over the life of the loan.
Struck out before? Try again
Schleck has an encouraging word for borrowers who may have struck out on a previous refinance effort.
“If you tried to refinance a few years ago and you had a problem, I wouldn’t let that discourage you,” he says. “Call someone up, get back in front of a mortgage banker and have them take another look.”
More from NerdWallet:
- Should I Refinance My Mortgage?
- Compare Mortgage Rates
- 7 Steps to Maximize Mortgage Refinancing Savings
Hal Bundrick is a staff writer at NerdWallet, a personal finance website. Email: hal@nerdwallet.com. Twitter: @halmbundrick
Image via iStock.
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