Unlocking Benefits: How to Refinance your Adjustable-Rate Mortgage

Do you have an adjustable-rate mortgage, more commonly known as an ARM? If so, then you may be wondering about the process and benefits of refinancing your adjustable-rate mortgage. Refinancing your loan can be beneficial, but it’s important to do it at the right time and in the right way if you want to avoid overpaying. 

At Addition Financial, we work hard to make sure our members understand the ins and outs of mortgage refinancing. In this post, you’ll find all the details you need to make an informed decision about ARM refinancing, including tips about market conditions, interest rates, closing costs and more.

How does an ARM work?

Most mortgages are fixed-rate mortgages, which means that there is one interest rate that remains in place for the entire term of the mortgage. Monthly payments are predictable and it’s easy to budget because your mortgage payment never changes.

Adjustable-rate mortgages work differently. There is an initial interest rate that’s usually lower than what you would find with a fixed-rate mortgage. The initial period may range from six months to 10 years and during that time, your monthly payment will be based on the low initial rate. After the initial period ends, your rate will be subject to change at regular intervals.

Lenders adjust rates for ARMs by adding a margin to an index rate. The margin is fixed, but the index rate may rise and fall based on market conditions. Many ARMs have a cap on how much the interest rate can be increased, but some also allow lenders to limit decreases. 

The most common ARM term is 5/1, which means that the initial interest rate will be in place for five years, after which your rate may be adjusted once per year. Caps on increases may be placed for the initial increase, periodic increases and for the lifetime of the mortgage loan, and it’s common for the initial mortgage interest rate increase not to be included in the lifetime rate cap.

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When should you refinance your ARM?

There are many circumstances when you should consider refinancing your adjustable-rate mortgage. Here are some questions that can help you determine whether refinancing is the right choice for you.

Are you nearing the end of your initial period?

The biggest sign that it may be time to refinance your ARM is if you have reached the end or are nearing the end of your initial period. It’s common for homeowners to see an increase in their rate at the end of the initial period and that may be reason enough to refinance.

Have your financial circumstances improved?

If your credit score and other financial circumstances have improved since you got your mortgage, then refinancing can help you save money with a lower interest rate and lower monthly payments. (This is true with a fixed-rate mortgage, too!)

Are interest rates on the rise?

The housing market fluctuates and with those fluctuations come increases and decreases in interest rates. If you see that interest rates are on the rise, you may want to think about refinance even if you’re still in your initial fixed-rate period.

Are you concerned about future mortgage rate increases?

On a related note, it’s common for homeowners with ARMs to be concerned about future rate increases and how they’ll impact their budgets. If having an ARM is stressful because you’re worrying about what will happen to your mortgage rate in the future, then refinancing can alleviate your stress.

How long do you plan to stay in your home?

People who buy starter homes or who plan to flip a house and resell it often choose an adjustable-rate mortgage because of the low initial interest rate. If you change your mind about moving or selling and want to stay in your home for a longer period than you initially thought, then refinancing makes sense.

How soon can you refinance an ARM?

One of the ARM refinancing questions we hear most often relates to how soon you can refinance an ARM after you get your mortgage. There are several factors to consider.

Home equity

The first consideration is home equity. While requirements may vary from lender to lender, virtually all lenders require a minimum of 20% home equity before refinancing is an option. Even if you don’t want a cash-out refinance, you still need enough equity to qualify.

If you made a substantial down payment or have lived in your home and made mortgage payments for a while, you may have enough equity to qualify for ARM refinance. You can use our free mortgage refinance calculator to determine whether you qualify.

How long you’ve lived in your home

In most cases, you won’t be able to refinance your adjustable-rate mortgage right away, even if you have at least 20% equity.

Most lenders require homeowners to have lived in their house for a minimum of six months before they will approve them for refinancing.

Personal credit and finances

As we noted above, your personal credit and financial circumstances will also play a role in determining whether you can (and should) refinance. Your income, debt-to-income ratio and overall financial stability all factor in.

If you’ve been struggling to make your payments or have experienced financial stress, then you may want to wait a while before refinancing your adjustable-rate mortgage.

Market conditions

Market conditions should be a consideration when you’re deciding whether to refinance your ARM.

When interest rates are high and/or climbing, it may not be the best time to refinance unless you’ve also had a substantial improvement in your credit and financial situation.

How do you refinance an ARM?

Here are the steps to follow if you decide to refinance your adjustable-rate mortgage:

  1. Review your finances. Before you refinance your ARM, review your credit score and finances to make sure you’re meeting the requirements for refinancing. As a rule, you’ll need a credit score of at least 620 (580 for FHA and VA loans) and a debt-to-income ratio no higher than 60%. Requirements vary by lender.

  2. Research lenders. It’s always a good idea to research lenders and rates before you apply. Keep in mind that credit unions usually offer lower interest rates than banks.

  3. Gather documents. Any lender you choose will require documentation that includes proof of income and employment, bank statements, tax returns and other financial records.

  4. Apply for refinancing. Complete the mortgage application for your chosen lender(s) and provide all necessary documentation. You’ll also need to pay application fees at this stage.

  5. Review your Loan Estimate. Lenders must provide a Loan Estimate to borrowers within three business days of receiving a completed loan application. This is a good time to go back to your lender with questions or concerns about your loan.

  6. Go through the appraisal process. All lenders require an appraisal of your property, since they will use the appraisal to determine how much money you can borrow.

  7. Go through the underwriting/approval process. Your lender will review your documentation and finances and decide whether to approve your loan. Your job during this process is to be patient and to answer any questions promptly to avoid delays.

  8. Lock in your interest rate. After you’re approved, you may have the option to lock in your interest rate. Doing so will guarantee that your rate won’t increase between approval and closing.

  9. Review your Closing Disclosure. Your lender is required to provide a Closing Disclosure to you no later than three business days before closing. Make sure to review it carefully and notify your lender of any errors or omissions.

  10. Sign your loan documents at the closing. The final step is to schedule and attend your mortgage loan closing. At the closing, you’ll sign all loan documents. You should bring your Closing Disclosure, so you can compare the rates and terms in the documents you’re signing to what’s in the disclosure. You’ll also need a photo ID and a cashier’s check to pay for your closing fees and other expenses. You may want to bring a lawyer to guide you.

These 10 steps will help you get through the research, application and approval process with minimal stress.

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What are the benefits of refinancing an adjustable-rate mortgage?

Here are some of the important benefits of refinancing an adjustable-rate mortgage:

  • You can avoid uncertainty in mortgage rate fluctuations if you refinance before your initial period ends.

  • You can save a significant amount of money in the long term if you apply for a fixed-rate mortgage instead of an ARM.

  • You won’t have to worry about your interest rate potentially increasing in the future.

  • You’ll have an easier time budgeting than you would with an ARM.

  • You may be able to tap into your home equity to pay for other expenses, including home improvements, college tuition or credit card debt.

Depending on market conditions, there is a risk that you could end up with a higher interest rate than the initial rate on your ARM if you refinance to a fixed-rate mortgage. The trade-off is that you’ll have the peace of mind of knowing your rate will remain the same after you lock it in.

Get affordable ARM refinancing with Addition Financial

Refinancing an adjustable-rate mortgage may be the right decision in a variety of circumstances, and it offers relief from stress that your interest rates will go up and you won’t be able to afford your monthly mortgage payments. The information we’ve provided here will help you navigate the process and get a new mortgage loan that works for you.

Are you looking for a lender that cares as much about your financial future as you do? Addition Financial has affordable mortgage refinancing options, including fast track refinancing and jumbo loan refinancing. Click here to learn more and start the application process today!

The content provided here is not legal, tax, accounting, financial or investment advice. Please consult with legal, tax, accounting, financial or investment professionals based on your specific needs or questions you may have. We do not make any guarantees as to accuracy or completeness of this information, do not support any third-party companies, products, or services described here, and take no liability or legal obligations for your use of this information.