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.