Should I Refinance My ARM with a Fixed Rate or Another ARM Mortgage?

Adjustable rate mortgages (ARMs) can save the homeowner a lot of money in certain circumstances. If you have held an ARM in the past several years, it probably did make your interest rate and payment lower. But how about in 2018 and beyond? Rates are generally on the rise, with 30-year fixed rate mortgages in the 4.8% range and could touch 5% next year. So, if your ARM is about to reset, should you get another ARM or go fixed?

At the beginning of 2018, Freddie Mac Primary Mortgage Market Survey indicated that 30-year fixed rate loans were averaging 4.2% and 5/1 ARM loans were at 3.33%. Today as of November 2018, five-year ARMs are clocking in at 4%, while a fixed rate 30-year mortgage is 4.875%.

As of today, you will do .8% better or so with a five-year ARM. But the risk of an ARM is obvious. The interest rate environment is rising. If you are planning to stay in your home beyond five or seven years, you run the risk of getting a much higher rate down the line. Before you take out a new ARM in this rising rate environment, experts advise you get a Truth in Lending disclosure. This should show the maximum amount your mortgage payment each month could hit. You should make sure that you are really comfortable with this mortgage payment before you make the decision.

Of course, there are times when getting another ARM could be a great decision. As we have seen, an ARM rate now starts about .8% lower than a fixed rate mortgage. Your monthly payments are much lower for a few years.

If it turns out that rates decline in the five to seven-year period, your payments might decrease when the rate resets. While rates are rising now and in the medium term, it is certainly possible we could have a recession in the next five years that could cause rates to sink.

Before you decide to get another ARM, you should investigate what the caps are on how much your mortgage payments can rise, both each year and over the life of your loan. This might be written in your loan documents as 2/2/5. The first number shows the largest amount by which the rate can go up in the first year after the fixed rate period of 3,5 or 7 years ends. The second number illustrates the most it can change each year. The third number shows how much it can go up over the life of your loan.

Let's talk a real-world example. Assume you buy a home with a $250,000 house with a 30-year, 5/1 ARM. The initial rate is 4% and you put down 20%. Your monthly payment at first would be $950. In a perfect world, your payment would not rise over the life of the loan and you get the house for about $345,000 with interest.

But this is the best case. Let's say now that after your five-year fixed rate ends, the rate goes up by .25% per year until it hits the maximum amount of 5%. This could spike your rate to 9%! You will be paying $420,000 over the life of your loan. The monthly payment would rise to $1300.

These are the extreme scenarios, and the most likely is something in between them. But if you get a new ARM and the rate hits the cap, you will pay thousands more in interest.

For most of us, fixed rate mortgages are the better choice. This is definitely true if you want to stay in the home for five years. You might want to pick the ARM if you are sure you only will be in the house for three or five years.

The bottom line is this: Rates are rising at the end of 2018. Fixed rate mortgages for 30 years are at 4.875%. A five-year ARM is at 4%. If you are very confident you will move before the rate resets, you might go for a new ARM. But if you are less sure, you may want the safety of a 30-year fixed rate loan. Sure, the payment is higher, but at least you know it cannot rise more than 4.875%.

References: https://www.fool.com/credit-cards/2018/07/28/should-i-get-a-fixed-or-adjustable-rate-mortgage.aspx