Should you refinance an adjustable-rate mortgage?

How ARMs work

ARMs typically start out at lower rates than fixed-rate mortgages. After a period of time — say five or seven years — the rate will adjust annually for the remainder of the loan. A 5/1 ARM has a rate that's fixed for five years, then can change every (one) year; a 7/1 ARM works in similar fashion after an introductory period of seven years.

Refinancing to a fixed-rate loan eliminates the risk your interest rate will ever go up and you’ll find yourself stuck with higher monthly payments.

Rates on ARMs typically move up or down in sync with a benchmark interest rate like the prime rate, which is the rate commercial banks offer their most creditworthy customers. Most ARMs have caps on how high your rate can potentially go.

The prime is tied directly to the Federal Reserve's federal funds rate, and the Fed has indicated it's not likely to raise its rate before 2024. So if you've got an ARM indexed to the prime, your rate isn't likely to change soon — but a rate increase is always possible off in the future.

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Beware of rising fixed mortgage rates

If you want a mortgage without that rate uncertainty, your window for refinancing your ARM into a cheap fixed-rate mortgage is rapidly closing. The average rate on a 30-year fixed-rate mortgage has been rising for most of 2020 and is the highest it’s been since at least June, according to mortgage giant Freddie Mac.

Rates on America's most popular mortgage slid to an all-time low average of 2.65% at the beginning of January, but since then the typical 30-year rate has burst back above 3%.

“The run-up in rates continues to reduce incentives for potential refinance borrowers," says Joel Kan, the associate vice president of forecasting for the Mortgage Bankers Association, in a news release.

For now, rates under 3% are still available — if you look hard enough.

How to get the best deal on a fixed-rate mortgage

To refinance your adjustable-rate mortgage at the lowest fixed rate you can get, you'll need to shop around. Different lenders can offer hugely different rates, so gather and compare rates from at least five lenders to get the best mortgage interest rate.

Multiple studies have found that five is the magic number for finding a low rate that will save you thousands over time, versus the other mortgage offers.

To impress a lender, you'll need to show a stellar history with your mortgage payments — and a solid credit score. If you're not sure what it is, these days it's very easy to check your credit score for free.

Depending on how long you've had your ARM, a new fixed-rate loan might even have a lower rate and lower monthly payment that your adjustable-rate mortgage. You could use the savings to pay down debt, or boost your investing — maybe by using an app that helps you build your portfolio using just "spare change."

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