If your home is financed with an adjustable rate mortgage, or ARM, you’ll eventually be faced with a decision. That’s because ARMs have a fixed rate only for an initial period of 3, 5, 7 or 10 years. After that, your lender will start adjusting your rate every year.
If your timing is lucky, you could see a downward rate adjustment. But often, you’ll find yourself looking at higher monthly payments for the next year.
Once in the adjustment period, your lender will recalibrate your rate every 12 months, and you have three main options on how to respond. You can do nothing and accept the new rate. You can refinance into a new ARM, starting over with a new fixed-rate period. Or you can eschew adjustments by refinancing into a fixed-rate mortgage.
Your best choice will depend on a number of factors. Certainly, if your adjustment will lower your payment, you’ll want to do nothing and enjoy your good fortune. But that scenario isn’t especially likely for those with ARMs currently moving into adjustment, as rates have inched upwards over the last 5-6 years.
If your rate will go up significantly, refinancing can be a smart option, with ARMs making good sense if you expect to move in the next handful of years, and fixed-rate mortgages being better if you plan to stay for many years.
Another consideration is the cost to refinance. Though moving out of one ARM into another with a lower rate can be attractive, the gains must be weighed against the refinancing expenses you’ll incur. Keeping your current ARM could turn out to be more economical.
Of course, if you don’t refinance, this decision will come upon you again in a year, when your next rate change is announced. And all of the same considerations will apply.