Refinancing can be done for many reasons, but switching from an adjustable-rate mortgage (or ARM) to a fixed-rate mortgage is one of the most common.
The general rule of thumb is that refinancing to a fixed-rate loan makes the most sense when interest rates are low. While no one can predict whether rates will go up or down in the future, many homeowners are currently taking advantage of today’s low rates to refinance from their adjustable-rate mortgage to a new fixed-rate mortgage. If you’re among those who are considering this move, here are some points to be aware of.
Potential benefit of a fixed-rate loan
The main benefit is stability. While an adjustable-rate loan’s monthly payments can fluctuate, the monthly payment of principal and interest on a fixed-rate loan will stay the same throughout the life of the loan. This can make it easier to set your monthly budget and can also provide peace of mind. With a fixed-rate loan, your principal and interest payments won’t go up even if market interest rates increase.
Fixed-rate loan considerations
Fixed-rate loans tend to have higher interest rates than adjustable-rate loans, especially compared to the first years of an adjustable-rate loan during which the interest is often fixed for a specified period of time (typically 5, 7 or 10 years). Of course, if you have a fixed-rate loan and interest rates fall, your principal and interest payments won’t decrease accordingly.
Any time you refinance, you’ll be responsible for paying closing costs. In addition, if you extend the term of your home loan (for example, by refinancing a 30-year mortgage into another 30-year mortgage after you’ve already owned your home and made mortgage payments for 5 years), you may pay more in total interest expenses over the life of the new refinance loan compared to your existing mortgage. You may be able to avoid this situation by making monthly payments toward the new, lower fixed-rate loan in an amount equal to or greater than what you previously paid toward your original loan. It’s important to discuss your situation with your lender to ensure that you’re comfortable with how these costs will impact your overall financial picture.
Accomplishing your other goals
If you choose to refinance to a fixed-rate loan, you may also have the opportunity to make additional changes to your loan at the same time. Depending on your circumstances, you may also be able to lower your monthly payments, shorten your loan term or borrow from a portion of your available home equity. Talk to your lender about what you’d like to accomplish and see what’s achievable for your situation.