I was looking at rates on hybrid adjustable-rate mortgages the other day and thought it could make sense for some folks to refinance out of their fixed mortgages if they plan on moving relatively soon.
There are a variety of hybrid ARMs that have a fixed rate period, with the most common being three, five, and seven years.
This means the rate won’t change for the first three, five, or seven years, respectively, giving the homeowner some peace of mind despite it being adjustable and at the mercy of market forces.
Critics of such a move would probably point to the near-record low fixed mortgage rates currently available. Why refinance to an ARM when your fixed rate is 3.75%? That would be foolish, wouldn’t it?
Are You Staying for 30 Years?
I’ve said it before – most homeowners don’t stay in their homes, or with their mortgages, for very long. It’s not uncommon for borrowers to sell just a few years after buying a home for a variety of different reasons.
That means many folks don’t actually benefit from their fixed mortgage. In fact, they’re paying a premium for something they don’t even utilize.
Of course, you can argue that they sleep better at night knowing their mortgage rate will never rise, but that day may never come anyway, and it could all just be needless worry.
The fixed rate is certainly worth something, but maybe less than homeowners actually think.
How About that ARM?
Back to those rates as I was looking at. I was actually scanning through rates on my own site in the table at the bottom of my posts.
Some lenders are advertising rates of less than 2% on the 3/1 ARM, which affords borrowers 36 months of fixed payments without the worry of a rate increase.
There are fees involved surely, so perhaps a rate of 2.5% at no cost might be a more reasonable assumption.
Let’s pretend a homeowner is currently paying 3.75% on a 30-year fixed on a $350,000 mortgage that now has a balance of $325,000.
The monthly payment is $1,620.90 and that doesn’t ever change. That’s pretty low but can the homeowner do even better if their expectation is to move/sell in the next few years?
Well, let’s say they refinance into the 3/1 ARM and get an interest rate closer to 2.5% without paying lots of fees. You don’t want to pay fees if you’re not in it for the long-haul.
The monthly payment on a $325,000 mortgage (assume it was paid down for some years) set at 2.5% is only $1,284.14. That’s nearly $340 in savings each month.
If our hypothetical borrower holds the loan for the maximum amount of time before it’s subject to a rate adjustment the total savings are potentially $12,000.
Additionally, the loan balance would get paid down faster because a lower interest rate means more of the monthly payment is going toward principal, as opposed to interest.
So the homeowner would be in good shape with regard to their remaining balance on the loan as well, even if they reset the mortgage to a new 30-year term (yes, a 3/1 ARM is still a 30-year loan).
You’re Definitely Moving, Right?
The huge caveat here is that you need to be sure you’re going to move and sell the place before the rate adjustment. Not just not living it (and renting it), but actually unloading it and the associated mortgage.
I don’t know how many people know this type of thing with certainty, but I’m sure there are plenty out there.
If you do, it would certainly make sense to look at a short-term ARM to see if there are any potential savings.
If you’re growing your family, planning a move to a new state, starting a new job elsewhere, etc., in the foreseeable future, a switch to an ARM could be a big money-saving move.
You’d even have some more cash for a down payment on the next property you buy.
On the other hand, if there’s an outside chance you may move, but probably won’t, it’s likely best to stick with your fixed mortgage and enjoy the historically low interest rate.
You don’t want to look a gift horse in the mouth.