Tough Times Series: What to Do When Your ARM Is Due
Dianne Molvig
If you have an ARM (adjustable-rate mortgage) and your fixed-rate period is drawing to an end, your first rate adjustment is looming. It's time to devise a plan.
Many ARM borrowers face that task with uncertainty. In fact, many homeowners with ARMs say they don't know what they'll do when their rate adjusts. If you're among those who feel unsure, consider a few pointers.
Take stock
Begin by closely examining the ARM you have. How often can the rate adjust? How much can it rise at each adjustment? How much will your monthly payment increase at each adjustment? What's the limit on the rate increase over the life of the loan?
The first thing you have to do is know where you're at. Ask a credit union loan officer for help in analyzing your ARM contract.
Many consumers got their ARMS elsewhere, sometimes from mortgage brokers who glossed over the details when issuing the loan. Those borrowers end up poorly informed about the ARMs they hold. Some homeowners don't even know what type of mortgage they own, much less the loan details.
Many homeowners with ARMs say they don't know what they'll do when their rate adjusts.
Talk to a loan professional at your credit union, whether or not you got the ARM there. He or she can help you understand your ARM, review your options, and decide what to do next, based on your individual circumstances.
Weigh your choices
If your ARM is coming due for adjustment�or even if you have some time before you'll face that decision�you have three basic options:
Refinance into a fixed-rate 30-year (or shorter term) mortgage.
Refinance into a new ARM that has terms better suited to your situation.
Stay with the ARM you have now and take the rate adjustment.
Refinancing into a fixed-rate mortgage means you'll never have to worry about rate adjustments again for as long as you live in your home. Usually the interest rate on a fixed-rate loan is higher than for an ARM but that depends on the economic environment at that time.
If your ARM is coming due, you first need to fully understand what that ARM is.
Another possible obstacle to refinancing into a new mortgage is closing costs, which usually run 2% to 4% of the mortgage amount. A $200,000 mortgage, for example, could have closing costs of at least $4,000. What's more, your current ARM may have prepayment penalties, which can be several thousands of dollars. Check your contract.
Still, it may be worth spending the money to refinance to a fixed rate if you plan to stay in your house long enough to recoup the costs. As a general guideline, your length of stay should be at least three to five years. But that will depend on exactly what your closing costs and any prepayment penalties add up to.
Another option is to switch to a new ARM with better terms than the one you have. You'll face the decision again in a few years about what to do when the rate adjustment hits. A new ARM might be a viable option for a borrower who plans to sell the house in a couple of years. In the meantime, you'd save a bit on the monthly payment. But again, factor in closing costs and any prepayment penalties.
It may be worth spending the money to refinance to a fixed rate if you plan to stay in your house for at least three to five years.
"Keep in mind that if you choose an ARM today, interest rates could go up when your ARM adjusts in a couple of years," says Steven Rick, senior economist with the Credit Union National Association, in Madison, Wis. "On the other hand, a decline in interest rates can lower your monthly payment. When you take out an ARM, you are taking the risk—interest rates rise and fall. When you take out a traditional fixed-rate mortgage the financial institution is taking the interest rate risk."
Stay putStaying in your current ARM may make sense if you plan to sell your house soon.
Finally, you could keep your current ARM and take the adjusted rate if it is attractive. That buys you some time to see what interest rates do, which, of course, is anyone's guess. You'd have to be willing to take your chances and live with the uncertainty.
The other thing to consider is how long you want to be in that house. If you're in a 3/3 ARM and you plan to sell within 24 to 36 months, it might make sense to remain in your current ARM.
Unfortunately, some homeowners with ARMs coming due can't afford the refinancing costs on a new mortgage or the higher payments a rate adjustment will trigger on their current ARM. Or the house may have lost value and no longer will appraise at the value they hoped for. These homeowners feel stuck, and selling their home may seem the only way out.
For them, we repeat our earlier suggestion: Talk to people at your credit union, whether you're looking for loan advice or help with budgeting so you can afford your mortgage.
Published September 11, 2009
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