Switching from ARM to Fixed Rate

[mtgordon]

How do people go about making this decision? I currently have 3 years left on my 5 year ARM at around 5.25%. How do I decide if I should switch to a fixed rate or not? Should I just assume that when my 3 years are up I'll get an average rate where average is the average rate for the last 20 years?

I'm sure there are other factors that need to be included (maybe age, financial situation, etc) so feel free to ask a bunch of questions about me first.

Thanks

[polkaface]

When you signed up for your ARM you should have been given terms of the adjustment.

How often it adjusts,
what the cap per year is (most your rate can move in 1 readjustment),
what the overall cap is (highest rate you can ever be charged),
and what index is used to figure out your rate

If you can find those items, you can start to see if problems could lie ahead and how soon those problems might come up.

The goal obviously is to pay the least amount of interest. So the question that needs answering is when will you hit that point (which will be a guess) when your ARM will have a higher interest rate than what you could get for a fixed.

There will almost certainly be a point in which this line will be crossed, but it will take some guesswork and forecasting to make an educated guess.

In the meantime, you obviously will want to make sure your credit is only getting better and not worse, so that if/when you do want to refinance you can get the best rate possible.

[mtgordon]

So it's a little bit of research (on my loan specifications) and a lot of guesswork (as to where the rates are going) or a ton of research to figure out where the rates are going?

[polkaface]

Well, it is a little bit of research (everything should be on your loan doc clearly stated).

It is a little bit of guesswork for an absolute optimal best decision. You can wait until it is an easy decision, but at that point fixed rates will be a little higher than they would have been had you moved earlier and "guessed".

All it is, is an NPV decision. Is the PV of your new fixed future payments, plus the costs of refinancing less than the PV of your current deal. Most people when doing this calculation make it easy on themselves and just use what they know right now and not really forecast anything.

For instance if you have a (all made up #'s) deal where you are getting 5.25% right now under the entry period deal but your readjustment will be 2%+ the index (lets say 30yr treasury) but it can only go up 1% a year and only to a max of 9%

30 year right now is 5.16 so my rate would be 7.16 (if adj were to hit now, or if rates stay the same until readjustment does hit whenever that is), however I can only be raised 1 percentage point so that next year my int. rate would be 6.25 and then the following year it would be raised again to 7.16 to 7.25 (assuming no drop in 30 year treasury).

So once you find out your loan specifics you can start to put together the key numbers and what they are currently at and what you can start to look forward to when the rates adjust.

I hope this all makes sense.

[Uglyowl]

Start to track the 30 year fixed mortgage rates out there. The recent low was around 6%, right now it is around 6.625%.

You have plenty of time, enjoy your 5.25% while it lasts, but start to weight time remaining vs. current interest rates offered vs. rate reset rate to pull the trigger.

The all-time floor for 30 year mortgages has been a tad under 5.50%. Patiently wait and start to weight the above. I very much doubt we will see 5.50% any time in the near future.

With your current situation (3 years left, current offering 6.625%), you are not close to pulling the trigger. If it was me, I would need <6% right now with 3 years left of the original rate.

[DesertCat]

You are going to save 4.1% over the next three years by staying put (plus the costs of the refi). Even if you refi at a fixed 7% in three years it would take you over 10 years to pay that back. And you will likely sell or refi at a lower rate within that 10 year period anyways.

And I'm not even counting the time value of money, which makes your savings from the next three years worth much more than the same amount of interest over the ten years after that.

My guess is that if you can refi at 7.5% or below in three years it makes sense to wait given the time value of money, the likelyhood of selling your home, or just refinancing at an even better rate. And remember if fixed mortgages are 7.5% in three years you can probably do an ARM cheaper.

[kiddcheckers]

A lot of the 5 year arms can bump 2% or more the first year of adjustment. Normally it's the 3 yrs that have a 1% cap. You may want to look at that.

Can you afford a fully amortized fixed payment? Think things will change and you'll be able to in the future.

You're two years in, how long's the pre-pay? Any thought to a 10 yr i/o sooner rather than later? Wamu has the best 10 year i/os imo. Get them backend though through a broker. I'm 100% you have at least one friend doing mortgages, everyone does. All the brains agree rates won't be better in 2 years then they are now. Just a thought.

Good luck either way.

[SossMan]

A lot really depends on how long you plan on keeping the house. If it's your dreamhome and you are planning on keeping it forever (either as primary or rental) then it's just a numbers game. 3 years is a long time and 5.25 is a low rate, so you would want to get something pretty good to make the switch. Obv, if you are planning on selling in the next 5 years, you wouldn't do anything. You likely have a cap on how high the first adjustment can be, so you would be fine even if it adjusts.

More details...

[VeryTnA]

All the advise here is good. Every major point is covered.

I am just wondering why you went with an ARM? What made you you choose the 5/1 out of all the ARM options available.

Refinancing is expensive. Get ready sticker shock, especially if you need to buy the rate down. The total refi cost and your new payment will be high. Have someone run figures for you now so that you can prepare.