Is it time to dump your ARM? By Beth Braverman, Money Magazine 10-21-2009

Is it time to dump your ARM?
Some 1.5 million adjustable-rate mortgages reset soon. If yours is one of them, you need to decide whether to lock in your rate and refinance into a new loan.
By Beth Braverman
Money Magazine
October 21, 2009

If you are among the 6.5 million homeowners who took out a low-rate adjustable-rate mortgage during the housing boom, you've probably spent the past couple of years waiting for your day of reckoning to come.

After all, you've probably heard repeated warnings that when your ARM resets your payments would spike dramatically: an especially big problem if you used a low-rate ARM to stretch for a home you could barely afford.

The good news is that scenario hasn't come to pass. Instead, interest rates have fallen to record lows, and when your ARM resets you'll probably see your monthly nut fall, not rise.

But once the economy stabilizes, the government will start peeling back the policies that are keeping mortgage rates low.

"Eventually rates are going to go up very significantly," says Greg McBride, a senior financial analyst at Bankrate.com. The Mortgage Bankers Association predicts fixed mortgage rates will reach 5.9% by the end of 2010 and 6.3% by the end of 2011.

To see what could happen to your payments later on, look on your mortgage documents to find the cap, or the number of points your rate can move in any given year after the first reset (one or two is typical), as well as the lifetime cap on your loan. Then figure out if you should refinance now and what kind of mortgage you should get if you do.

Stand pat if ...
You plan to move in the next three years. In that case, the few thousand dollars you'll pay to refinance is likely to exceed any extra interest you'll pay on the mortgage before you move.

You have less than 20% equity in your home. If you bought in the past few years and real estate values in your area have taken a big hit, you may not qualify for the best rates. "That makes refinancing less attractive," says Wilton, Conn. mortgage broker Tim Malburg, Homeowners with a jumbo mortgage (more than $417,000 in most areas) are held to an even higher equity standard.

Refi to a 5/1 arm if ...
You'll be in your home for three to five more years. In mid-September, ARMs that were fixed for the first five years cost about half a percentage point less than 30-year fixed-rate loans. Over a five-year period, that could save you almost $10,000 on a $300,000 mortgage.

You have a jumbo loan. These large mortgages can feel like a rip-off right now, since rates for 30-year fixed jumbos are about a percentage point higher than those for smaller loans -- an unusually wide spread, says Keith Gumbinger, vice president at HSH Associates.

That's because the government has been purchasing loans backed by Freddie Mac and Fannie Mae, which has artificially driven down conventional-mortgage rates.

If you need a jumbo mortgage you'd knock about three-quarters of a percentage point off your rate by taking a 5/1 ARM. That would save about $3,300 a year for a half-million-dollar loan.

Refi to a fixed-rate loan if ...
You might be less attractive to a lender later on. If you'll need to take a big loan to pay your kid's college tuition, say, or think you might get laid off -- then it's worth doing the refi while you have the chance.

You'll be in your home five years from now. While most experts think that rates will stay low for a while, they're not likely to get much lower, and there's no guarantee they won't jump unexpectedly.

If you're planning to stay longer than five years, go with a 30-year fixed to eliminate any interest-rate risk, since rates on seven- and 10-year ARMs are only a notch lower than those on 30-year loans. And if you have any doubts about your time frame, lock in. After all, you don't want to be in this same predicament five or so years down the road.

You'll pay more to lock in a fixed-rate mortgage today. But a couple of years from now, holding on to that adjustable-rate loan could get costly.