Homebuyers settling down into their “forever home” usually choose a fixed-rate mortgage over an adjustable-rate mortgage (ARM).An ARM has an introductory period, usually 1 to 7 years, where interest is fixed. After the fixed-rate period ends, interest adjusts based on an index. Even though starting interest on an ARM is typically several points lower than a fixed-rate mortgage, choosing one is taking a gamble. You’ll never know for certain what your monthly payments will be in the future once interest starts adjusting. That’s enough to make anyone nervous.
In a recent post, we explained how choosing an ARM over a fixed-rate mortgage can actually be a smart move in certain situations. One situation being if you buy a home and sell it before the fixed-rate period ends. Another being, if you plan to live in a home for long-term, starting off with an adjustable-rate mortgage and then refinancing to a fixed-rate mortgage.
In both instances, you reap the benefits of low interest and get out of the adjustable-rate mortgage before interest becomes variable.
There’s also a third scenario to add to the case for choosing an ARM. If you currently have a fixed-rate mortgage and plan to sell your home in the next few years, you can refinance to an ARM and take advantage of low interest before you move.
This could be an ideal option if you’re in a “starter home” and planning to move on into your “forever home” in the near future.
Let’s consider a simple example. If you have a mortgage of $300,000 with a 30-year, fixed-rate of 4.50% interest, you’ll make monthly payments of $1,520.06.
If you have a $300,000 loan with a 5/1 ARM starting at 3.24% interest, you’ll make payments of $1,303.97 during the 5-year fixed period. That’s a savings of about $216 per month.
Add up the savings over 5 years and you can use it to prepare your current home for the market, as a down payment on a new home or to cover your moving costs.
You may be excited by the prospect of refinancing to cut your monthly mortgage payment, but there are some factors to think about first.
The closing costs should weigh into your decision. To come out on top of this refinance, your interest savings over time must surpass the cost of closing.
If you want to sell your home within a few months you probably won’t see the savings and costs break even. On the other hand, if you plan to sell your home within the next 5 years or so, you may be able to see significant savings.
Another factor to consider is the housing market. Go with a refinance if you feel fairly certain that you will, in fact, be able to sell your home. Speak with a real estate agent to get a feel for the market. You don’t want to get stuck with a home after the fixed-interest period on the loan ends. That will likely defeat the purpose of refinancing entirely.
Interested in learning more about your mortgage options or prequalifying for a home loan?