The vast majority of homeowners who are refinancing their mortgages are choosing fixed-rate loans, opting to lock in at a historically low rate. But many homeowners who currently have adjustable-rate mortgages (ARMs) charging even less may balk at this move, since it can increase the monthly payment.
Is keeping that ARM a mistake? It depends on the borrower’s situation and long-term plans, but there are some ways borrowers with ARMs can continue to enjoy today’s low rates and keep future risks in check.
The key risk, of course, is that the rate can go higher in future resets, which are typically done every 12 months after the first one, three, five or seven years. Right now, many borrowers with ARMs are paying at the mouth-watering rate of around 3%. That’s what you get by adding a typical 2.75-percentage point margin to the yield on Treasury securities with one year to maturity, a standard index for ARM resets.
A 3% rate leads to substantial savings over a 30-year fixed-rate loan, which averages 4.481%, according to the BankingMyWay.com survey. For a $200,000 loan, the ARM would charge $843 a month and the fixed loan $1,011, according to the ARM vs. Fixed Rate Calculator.
But the fixed rate is very low by historical standards, and it will stay the same for the life of the loan, while the ARM could go higher. Many ARMs have caps that allow rates to rise only as much as two percentage points a year or six points over the starting rate during the life of the loan. Five years ago, the initial rate was around 5%, so an ARM issued then could someday go as high as 11%.
How can a homeowner with an ARM continue to enjoy today’s low rate while minimizing the damage from any future rate hikes?