Refinancing your ARM into a fixed-rate mortgage
![A woman meets with her lender to refinance her mortgage.](https://www.bankrate.com/2020/05/13142658/Should_you_refinance_ARM_fixed_rate_mortgage.jpeg?auto=webp&optimize=high&crop=16:9)
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Key takeaways
- If you're nearing the end of your ARM loan's initial fixed-rate period and your rate will rise significantly, you might be considering refinancing to a fixed-rate mortgage.
- A fixed-rate mortgage provides more predictability, as the interest rate and your monthly payment stay the same for the loan's duration.
- You'll need to meet ARM refinance requirements to apply, and it's a good idea to compare offers from multiple lenders—not just your current lender.
If you’re nearing the end of the initial term on your adjustable-rate mortgage (ARM), you might be wondering if now is a good time to refinance to a fixed rate. Let’s break down how to refinance an ARM and when it’s a good idea to refinance to a fixed rate.
Can you refinance an ARM loan?
You can refinance an ARM loan and by doing so, you’ll replace your existing mortgage with a new one. In this case, it can be either another ARM or a fixed-rate mortgage.
With an ARM, many people choose to refinance due to their rate adjusting higher. It’s important to remember that refinancing isn’t free — you’ll have to pay closing costs. So, even if you’re refinancing to a much lower rate, it’s smart to calculate your break-even point to determine when you’ll start saving money.
Lenders typically offer specific mortgage refinancing loans, so you’ll use their refinance application form to apply. The fact that you already own the home can simplify the process.
Keep in mind that you can choose the lender when refinancing an adjustable-rate mortgage. It could be your current lender or a different one, depending on which institution can offer you the best rate, service and terms.
How to refinance an ARM
Refinancing an ARM is very similar to refinancing a fixed-rate mortgage. Before you start the process, make sure you meet the requirements. For a conventional mortgage, that generally means having a credit score of at least 620, a debt-to-income (DTI) ratio of 50 percent or lower and 20 percent equity or more (though some lenders will allow less). 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:
- Get and compare quotes: Don’t just assume you’ll refinance with your current lender. Instead, research multiple lenders and get quotes on rates, fees and terms that you can compare to find the best offer.
- Choose a lender and apply: Gather all of your financial documents and submit the paperwork to the lender of your choice.
- Schedule the appraisal: Most mortgage refinances require an appraisal. The lender will order it, and you’ll have to pay for it.
- Go through underwriting and close the loan: Just as when you applied for your initial mortgage, you’ll need to work with an underwriter to verify your finances. Once everything is in order, you’ll schedule a closing date where you’ll sign the paperwork and pay closing costs. Note: You can pay closing costs upfront or roll them into the loan.
Costs of refinancing an ARM
Remember: Refinancing isn’t free. Before switching from an ARM to a fixed-rate loan, make sure you understand how much it costs to refinance a mortgage. You’ll need to budget for a number of expenses, like an origination fee, appraisal fee and title services.
On the plus side, refinancing costs are often far less than the closing costs on a home purchase loan. The exact amount will depend on your loan size and where you live, but in general, these costs total 2 to 5 percent of your loan amount. As an example, if your new loan balance is $250,000, you could pay between $5,000 and $12,500 in closing costs.
Since refis are essentially new mortgages, the closing costs are pretty much the same as those of purchase loans. It’s possible you might skip a few (presumably, you won’t need a home inspection). However, since the fees are often percentages of the principal and you’re getting a smaller amount (having presumably paid down some of your mortgage), they’ll amount to less overall.
Benefits of refinancing an ARM to a fixed-rate mortgage
ARMs are more complex than fixed-rate mortgages. Fixed-rate mortgages keep the same mortgage rate throughout the loan term (usually 15 or 30 years). In contrast, an ARM is a 30-year loan with a fixed rate for an introductory period (typically three to 10 years). After this period, the rate adjusts every 6 months or once per year, based on a specific market index.
There are benefits to refinancing an ARM to a fixed-rate mortgage. While ARMs may offer an initial lower rate than a fixed-rate loan, once that introductory rate ends, your payment can go up significantly.
The idea of trading away the uncertainty of an adjustable-rate mortgage for the certainty of a fixed-rate mortgage is appealing, especially if you’re expecting an adjustment in the next year or two.— Greg McBride, CFA , chief financial analyst for Bankrate
Here are the main benefits of refinancing an ARM to a fixed-rate mortgage:
- Your payments are always the same: A fixed-rate mortgage gives you the certainty of predictable payments. Rather than wondering how the market and economic trends will impact your adjustable rate — and consequently your monthly payments — you’ll enjoy a bill that never changes for the entire loan term.
- You can budget more easily: With a fixed-rate loan, the stable sum you put toward your major housing cost allows you to more effectively budget for the other expenses in your life, both now and in the future.
- You still have options: If a 30-year mortgage sounds like a lifetime, you can also look at a 15-year fixed-rate mortgage. The interest rates on this type of loan are even lower than the rates for a 30-year fixed loan, but the tradeoff is that you’ll have higher monthly payments due to the accelerated timeline.
Downsides of refinancing an ARM
Refinancing an ARM to a fixed-rate mortgage isn’t always the right choice. Here are some of the potential drawbacks to consider before making the switch:
- You’ll need to pay closing costs: Even though closing costs on a refinance are typically lower than a purchase loan, they can still cost thousands — and reduce (or delay) the benefits you’d expect from refinancing.
- You might lose out on savings: If you refinance to a fixed-rate loan and rates drop, you won’t see any of the interest rate savings you would have gotten on your ARM.
- It could take longer — and cost more — to repay your mortgage: If you extend your loan term as part of the refinance, you could end up paying more in interest over the life of your mortgage. Plus, it’ll delay your payoff date.
Should you refinance an adjustable-rate mortgage (ARM) to a fixed-rate mortgage?
Can you refinance an ARM loan? Sure. But should you? The rising mortgage rates in recent years might make this less appealing if your ARM originated back in the pre-pandemic days.
“It’s possible for borrowers who got their ARM five years ago to still have a lower monthly payment and pay less in interest during the first year or two of rate resets than what they would pay on a new mortgage at today’s rates,” says Austin Kilgore, analyst for lender Achieve’s Center for Consumer Insights. And there are limits to the increases, too.
“While interest rates on new adjustable and fixed mortgages are significantly higher today than they were five years ago, the rate resets on an existing ARM have both an annual cap, typically 1 to 2 percent per year, and a maximum cap, typically 5 to 6 percent over the life of the loan,” Kilgore adds.
On the other hand, if your introductory rate is about to end, refinancing might make sense. With rates much higher now than they were, say, five years ago, the rate jump you might experience could be a shock. If you can secure a lower rate on a fixed-rate loan than the rate your ARM is about to adjust to, choosing to refinance an ARM to a fixed rate could be a smart move.
How to decide to refinance
So, can your ARM loan be refinanced for your financial gain? To find out in your specific situation, consider your:
- Credit score: You need to have a good credit score to get the best interest rate. “Someone coming up on the end of an ARM presumably has five or more years of timely mortgage payments on their credit history,” says Kilgore. “There’s a good chance their credit score is better now and they may qualify for something better.” If your score needs some work, however, you may want to wait.
- Financial goals: Before applying, determine why you’re refinancing. For instance, do you want to pay off your mortgage sooner, have a more predictable payment or cash in some of your equity for home improvements or debt consolidation?
- Longer-term plans: How long you plan on staying in the home is a big point to consider before refinancing. “If you’re only looking at being at home for three or four more years and you have four years before it resets, and a new loan is not at least three-eighths of a basis point lower than your current rate, you might as well stay in your ARM,” says Ralph DiBugnara, founder of Home Qualified, a digital resource for homebuyers and sellers. “There’s no financial benefit to move forward into a fixed rate.”
- Ability to afford closing costs: Refinance closing costs cost anywhere from 2 to 5 percent of your mortgage principal. That means, for a $300,000 mortgage, you may pay $6,000 to $15,000 in closing costs. You can roll these into your mortgage with a no-closing-cost refinance, but if you do that, remember that you’ll pay interest on them.
Ultimately, can you refinance an ARM loan? Absolutely. But the ARM refinance only makes sense if it helps you toward your specific financial goals. Compare rates and crunch the numbers to see if refinancing your adjustable-rate mortgage is right for you. And keep an eye on interest rate trends: if the percentages are declining, you might want to stick with that ARM after all.
FAQ
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The main disadvantage of an ARM is that your interest rate can increase after the introductory period ends. If that’s the case, you’ll have to put more money toward your monthly mortgage payments, which might mean putting other financial goals on hold or cutting back in certain areas of your life.
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If the interest rate on an ARM goes up, your monthly payment will also increase — and you’ll end up paying more interest over the life of your loan.
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Refinancing to an ARM might make sense if you want a lower rate right now — especially if you plan to sell your home in the next several years (or at least before the introductory period ends).You might also consider this option if you need more affordable payments now, but you’ll be able to handle large ones down the road — when you go to work after getting a grad school degree, for example.
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Yes, you can refinance an ARM to another ARM (as long as you meet the lender’s requirements).
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