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Refinancing Your Mortgage: ARM to Fixed

By Jeff Brown
Deciding whether to refinance a mortgage is pretty straightforward comparison of costs versus savings, if you’ll replace an old fixed-rate loan with a new one.

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By Jeff Brown
Deciding whether to refinance a mortgage is pretty straightforward comparison of costs versus savings, if you’ll replace an old fixed-rate loan with a new one.

But that’s a big “if.”

Many homeowners want to get out of adjustable-rate loans, and for them it’s trickier to tally the savings.

If a new fixed-rate mortgage would save you $200 a month and closing costs were $4,000, it would take 20 months for the savings to offset the costs. After that breakeven point, the refinancing really would save you $200 a month.

But homeowners with adjustable-rate mortgages don’t know what their payments will be years down the road, so they can’t pinpoint the monthly savings over the long term.

Refinancing is probably a good choice if your ARM charges, 7 or 8 percent, with the possibility of someday going to 10 or 12 percent. The 30-year fixed-rate loan now averages an astonishingly low 5.12 percent, according to the manybanking.com survey. That should provide ample savings to offset refinancing costs.

However, some older ARMs are now charging less than 4 percent, due to recent resets tied to indexes, like the one-year Treasury, that are at rock-bottom levels. Refinancing to a 5 percent fixed loan could increase your payments for now, though there’s a good chance it would allow you to avoid higher ARM payments later.

So how do you decide what to do?

Homeowners with ARMs can start by gathering key facts: the balance remaining on the current loan, the current interest rate and monthly payment, the index used to determine future rate adjustments, the margin added to the index to figure future rates, the date of the next adjustment and intervals between adjustments, the annual caps which determine the maximum amount the rate can rise or fall in each reset, the lifetime cap that sets a ceiling the rate can never surpass.

The homeowner also needs information on the new, fixed-rate loan: the closing costs, interest rate and monthly payment, 
In the first step, look at the monthly savings possible from the date of the refinancing to the next date the ARM would reset if you kept it. Because the ARM rate is fixed during this period, you can use the Refinance Breakeven calculator to see what savings you might achieve initially.

Next, use the Adjustable Rate calculator to see what your ARM payments would be in the worst possible case, if they were to go up the maximum allowed at every reset until reaching the lifetime cap.

Click the View Report button for a breakdown on monthly payments and compare them to the payments on the new fixed-rate loan from the breakeven calculator. This will give the shortest possible time to break even, since it produces the highest possible ARM payments.

After that, look at the history of your ARM index to get a sense of its highs, lows and averages over time. Experiment with these in the Adjustable Rate calculator for a sense of the savings you might realistically hope for.  While there’s no guarantee the future will be the same, this will give you a sense of whether your ARM rate is likely to rise as high as allowed.

HSH Associates has lots of historical ARM index data on its web site, or type your index name and the terms “graph” or “table” into your search engine.

In refinancing from an ARM to a fixed-rate loan, you can never know exactly how much you might save. So a big part of the decision comes down to peace of mind. With a fixed-rate loan, you know your payments will never change, while an ARM is always a gamble.

Of course, it’s essential to get the best fixed loan you can. Use the manybanking.com shopping tool to find the best deal. And watch for good offers from small lenders and even the big firms like LendingTree (Stock Quote: TREE) or Bank of America (Stock Quote: BAC).

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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But that’s a big “if.”

Many homeowners want to get out of adjustable-rate loans, and for them it’s trickier to tally the savings.

If a new fixed-rate mortgage would save you $200 a month and closing costs were $4,000, it would take 20 months for the savings to offset the costs. After that breakeven point, the refinancing really would save you $200 a month.

But homeowners with adjustable-rate mortgages don’t know what their payments will be years down the road, so they can’t pinpoint the monthly savings over the long term.

Refinancing is probably a good choice if your ARM charges, 7 or 8 percent, with the possibility of someday going to 10 or 12 percent. The 30-year fixed-rate loan now averages an astonishingly low 5.12 percent, according to the manybanking.com survey. That should provide ample savings to offset refinancing costs.

However, some older ARMs are now charging less than 4 percent, due to recent resets tied to indexes, like the one-year Treasury, that are at rock-bottom levels. Refinancing to a 5 percent fixed loan could increase your payments for now, though there’s a good chance it would allow you to avoid higher ARM payments later.

So how do you decide what to do?

Homeowners with ARMs can start by gathering key facts: the balance remaining on the current loan, the current interest rate and monthly payment, the index used to determine future rate adjustments, the margin added to the index to figure future rates, the date of the next adjustment and intervals between adjustments, the annual caps which determine the maximum amount the rate can rise or fall in each reset, the lifetime cap that sets a ceiling the rate can never surpass.

The homeowner also needs information on the new, fixed-rate loan: the closing costs, interest rate and monthly payment, 
In the first step, look at the monthly savings possible from the date of the refinancing to the next date the ARM would reset if you kept it. Because the ARM rate is fixed during this period, you can use the Refinance Breakeven calculator to see what savings you might achieve initially.

Next, use the Adjustable Rate calculator to see what your ARM payments would be in the worst possible case, if they were to go up the maximum allowed at every reset until reaching the lifetime cap.

Click the View Report button for a breakdown on monthly payments and compare them to the payments on the new fixed-rate loan from the breakeven calculator. This will give the shortest possible time to break even, since it produces the highest possible ARM payments.

After that, look at the history of your ARM index to get a sense of its highs, lows and averages over time. Experiment with these in the Adjustable Rate calculator for a sense of the savings you might realistically hope for.  While there’s no guarantee the future will be the same, this will give you a sense of whether your ARM rate is likely to rise as high as allowed.

HSH Associates has lots of historical ARM index data on its web site, or type your index name and the terms “graph” or “table” into your search engine.

In refinancing from an ARM to a fixed-rate loan, you can never know exactly how much you might save. So a big part of the decision comes down to peace of mind. With a fixed-rate loan, you know your payments will never change, while an ARM is always a gamble.

Of course, it’s essential to get the best fixed loan you can. Use the manybanking.com shopping tool to find the best deal. And watch for good offers from small lenders and even the big firms like LendingTree (Stock Quote: TREE) or Bank of America (Stock Quote: BAC).

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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