Time to Bail on Your ARM?

Adjustable-rate mortgages haven’t been too popular with loan applicants recently, accounting for a tiny fraction of applications. But some homeowners who already have ARMs are glad they do, as recent resets have left them paying extraordinarily low rates, often just over 3%.

Still, it could pay to put a refinancing on the New Year to-do list, as more and more surveys find economists and market experts expect interest rates to rise this year. There’s still a chance to switch to a 30-year fixed-rate loan at a terribly attractive rate of just 5.253%, according to BankingMyWay.com’s Weekly Mortgage Tracker.

Many ARMs reset by adding 2.75 percentage points to the yield on Treasury securities with one year to maturity, and with those paying a mere 0.47%, these ARMs are charging just 3.22%.

Switching to a loan that charges more than the old one takes lots of resolve. But, like buying stocks when the market’s in a slump, it can be a smart long-term move.

An existing ARM currently at 3.22% charges $701 per month for every $100,000 borrowed, assuming 15 years left on the loan, according to the Adjustable Rate Mortgage Calculator.

But many ARMs allow rates to change as much as 2 percentage points a year. That means it would take the payment to 5.22% at the next reset, and 7.22% in the one after that. At 7.22% for 13 years, the loan would charge $990 for every $100,000, a whopping increase.

What’s the worst case? That depends on your mortgage terms. But assuming you started a few years back with a loan at 4% with a 6-point lifetime cap, the rate could go to 10%, lifting payments to $1,195 per $100,000 if 12 years remained.

If that happened you’d kick yourself for missing the opportunity to lock in 4.689% available today on the average 15-year fixed-rate loan. If adjustable rates rise by 6 percentage points, you can be sure fixed rates will soar as well.

The problem, of course, is that no one knows how fast and far rates might rise. Certainly, it would not make sense to refinance an ARM currently charging bargain rates if you expect to move in a year or two. But if you expect to be in the home for many years, keep in mind that there’s a much stronger prospect for rates to rise than to fall or stay the same.

The first step is to review your ARM to see how annual resets are calculated. There are a number of indexes, and the “margin,” or percentage points added to the index value, varies. HSH Associates Financial Publishers shows rates on the most common indexes on the firm’s homepage.

The site also has historical data on ARM indexes, making it easy to see that today’s rates are unusually low. The one-year Treasury, for example, exceeded 3% just two years ago, and was about 5% three years ago.

Use the Adjustable-Rate Mortgage Calculator to gauge the best- and worst-case scenarios, then assess the costs and benefits or refinancing with the ARM vs. Fixed-Rate Mortgage Calculator.

If you decide not to refinance your ARM, think about making extra principal payments on the loan or setting aside some savings for paying down the debt at some point in the future. That way you will be able to reduce the debt if resets push the loan rate up, keeping your payments manageable.

Finally, use the shopping tool to chase down market-beating loans. Bank of America (Stock Quote: BAC), for instance, has a 15-year loan charging just 4.375%.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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