Many Americans are refinancing their mortgage rates right now due to the near record-low low interest rates we’ve seen since the start of the pandemic. There are tons of different refinance loans available, but in most cases, homeowners will choose to refinance to a fixed-rate mortgage.
You might be surprised to hear, though, that you have the potential to save even more by refinancing from a fixed-rate mortgage to an adjustable-rate mortgage (ARM). An ARM refinance gives you the same perks of any type of refinance, but often at a more competitive rate.
This type of loan isn’t right for everyone, though. It will depend on how quickly you’re planning to pay off the loan or when you plan to sell the house — but if this type of loan ends up being right for you, you could end up saving money with an ARM loan.
Fixed vs. adjustable-rate mortgages
Fixed-rate mortgages and adjustable-rate mortgages are the two most common types of home loans. Unless there are some special circumstances in place, almost all borrowers will end up with one of these types of mortgages.
What is a fixed-rate mortgage?
A fixed-rate mortgage has a set interest rate that doesn’t change throughout the loan. A 30-year conventional loan is the most common type of fixed-rate mortgage, as it offers the lowest monthly payment because the loan is spread out over a 30 year span.
This type of loan comes with a fixed interest rate and has set monthly payments that stay the same over the entire 30 year life of the loan. These mortgages are ideal for anyone who plans to stay in their home for many years and wants the certainty of a fixed interest rate.
What is an adjustable-rate mortgage?
An adjustable-rate mortgage (ARM) is a mortgage loan that has an interest rate that varies over the life of the loan. These loans generally start with a fixed-rate period of between 5 to 10 years on average. During this time, the interest rate does not change. But once the fixed-rate period ends, the interest rate will vary year by year for the remainder of the loan.
These loans are advantageous because the starting interest rate is generally lower than the rate you’d be able to get for a fixed-rate mortgage. ARM loans are ideal for people who plan to stay in the home for less than the fixed-rate period since they won’t have to worry about paying a higher rate down the road.
Why refinance into an ARM mortgage?
A record number of people are refinancing their home loans in 2020 due to historically low mortgage rates. Most people who refinance likely have a fixed-rate mortgage now and will probably refinance to a fixed-rate loan. In many cases, though, the absolute lowest rates are only available to those who opt for an adjustable-rate mortgage.
Take a look at Bank of America, for example. As of November 10, 2020, the starting interest rate on their 30-year fixed-rate refinance loan is 3%. But those who choose an adjustable-rate refinance loan can get a rate as low as 2.75%.
Bank of America’s ARM refinance loan has a fixed-rate period of five years. But other lenders may offer fixed-rate periods for up to a decade. During that period, you’d pay a full 0.25% lower interest rate than if you’d gone with the fixed-rate mortgage instead.
ARMs can be a bit of a gamble, though. Sure, you lock in a lower interest rate now, but it’s entirely possible that by the time your fixed-rate period ends, mortgage rates will have skyrocketed.
As a result, these loans are best for:
- People who plan to pay their mortgage down quickly enough to fully pay it off before the fixed-rate period ends
- People who plan to sell their home within the fixed-rate period
How to refinance to an ARM loan
Are you considering taking advantage of the historically low interest rates by refinancing your home loan? If you plan to pay off your house or sell within the next decade (or you don’t mind a bit of risk), you might consider opting for an ARM to save even more.
Just follow these steps to get started:
- Get clear about your goal. Before you refinance your fixed-rate mortgage to an ARM, get clear on why you’re doing it. Right now, many people are refinancing to take advantage of the low rates. Think about your situation and decide what you hope to get out of refinancing before moving forward with it.
- Check your credit score. The best rates are only available to those with solid credit scores and credit histories. The last thing you want is to sit down with a lender and find out that you’ve got a surprise on your credit report that’s hurting your score. Run your report and score ahead of time so you know what to expect.
- Consider what loan terms you want. Adjustable-rate mortgages come in multiple forms. Some might have fixed-rate periods of just a few years while others might offer as many as 10 years of a fixed rate. Think about what terms best line up with your goals and future plans.
- Shop around for the best rate. Don’t just get a loan from the first lender you talk to. Shop around and get rates for several mortgage lenders that offer the loan terms you want. Once that’s done, you can choose the one that offers you the best deal.
Tips for refinancing to an adjustable-rate mortgage loan
Make sure you understand the terms.
Mortgage terms can be confusing — and they get even more confusing when you’re talking about adjustable-rate mortgages. Make sure you fully understand what you’re getting yourself into before you finalize your loan. The last thing you want is to get a surprise interest rate hike in a few years when you thought you’d get to enjoy the low rates longer.
Do your homework.
Many mortgage lenders publish their rates on their websites. As a result, you don’t necessarily need to apply with every lender under the sun to find the best deal. Shop around online and figure out who offers the overall best rates for the loan you want. After you’ve shopped around, you can apply to the handful of lenders with the lowest published rates.
Run the numbers.
Before you close the deal, run the numbers to make sure refinancing actually makes financial sense. In many cases, the closing costs that come with a refinance loan mean you’d have to stay in the home for a certain number of years before you start saving. Figure out your break-even point and decide if it makes sense.
Try boosting your credit score first
People are in a rush to refinance in 2020 because of the historically low rates. But you only benefit from those rates if you have a good credit score. If your credit score is lower than you’d like or you have some negative marks on your credit report, you’re probably better off taking some time to boost your score before trying to refinance your mortgage.
Too long, didn’t read?
Most people who refinance their mortgage opt for a fixed-rate loan, meaning they pay the same interest rate for the entire life of the mortgage. That may not always be the most fiscally responsible option, though. Interest rates are typically lower for adjustable-rate mortgages (ARMs), so you need to make sure to do your due diligence on this type of loan before making a decision. If you’re considering a refinance in the near future, consider your goals and whether an ARM would be a more cost-effective option.
