Can You Refinance an ARM? And Should You?

If you have an adjustable-rate mortgage (ARM), it’s only a matter of time until your interest rate begins to fluctuate, possibly driving your monthly mortgage bill higher. Perhaps you yearn for the peace of mind of a fixed-rate mortgage loan’s more predictable monthly payments.

That begs important questions: can you refinance an ARM loan? If so, what’s involved with a refinance from an ARM to a fixed-rate mortgage? And what are good reasons to refinance an ARM to a fixed-rate loan? Read on for helpful information and answers.

Key Takeaways

• Refinancing an ARM allows borrowers to sidestep potential rate increases, lower monthly payments, or tap into home equity for expenses such as renovations or education.
• Opting for a fixed-rate mortgage offers stability, protection from rising rates, and predictable payments, though it may come with higher initial rates and closing fees.
• Choosing to refinance into a new ARM can be advantageous if you plan to sell or refinance again soon or if rates remain steady, but it comes with the possibility of future rate hikes.
• To refinance successfully, you must meet lender criteria, account for closing costs, and evaluate whether the long-term savings justify the upfront expenses.

ARM Refinance Options

Tired of worrying about your ARM’s rate adjusting upward in unexpected ways? You’re not alone. Many ARM borrowers look to get out of their existing ARM for several key reasons.

“Refinancing an ARM can be a smart move for borrowers looking to avoid potential rate hikes as their adjustable period begins. For example, if you are nearing the end of a 5/1 ARM with a current interest rate of 4% and a projected adjustment of 6%, refinancing into a fixed-rate loan at 5.25% would lock in an electable monthly payment,” explains Carl Holman, director of Communication and Content for A&D Mortgage. “This can save you significant money over time if rates continue rising.”

Another refi rationale is to decrease your monthly payment. Imagine your ARM began at 5% on a $300,000 loan, but market rates drop. Then, let’s assume you could refinance into a new 5/1 ARM at 4%.

“That 1% reduction lowers your monthly payment by approximately $250 – freeing up cash for other financial priorities,” Holman continues.

How we source rates and rate trends

Aside from locking in a lower interest rate and ditching concerns over ARM adjustments and fluctuating rates, there’s another motivator for leaving your current ARM.

“Perhaps you want to tap home equity. If your home’s value has shot up, refinancing to a fixed-rate cash-out mortgage loan could unlock that equity for renovations, tuition costs, medical bills, or whatever you need to pay for,” notes personal finance expert Andrew Lokenauth.

In summary, if you currently have an ARM you want to refinance, you have two choices:

1. Refinance into a new ARM
2. Refinance into a fixed-rate mortgage loan (either a rate-and-term or cash-out refinance loan)

Let’s take a closer look at the pros, cons, and steps involved with each option.

Reasons to Refinance an ARM into a Fixed-Rate

Refinancing your ARM to a fixed-rate mortgage loan offers two key advantages many borrowers prefer: stability and protection against rising rates.

“Suppose you have a $300,000 5/1 ARM loan for which you pay $1,265 monthly. But it’s been five years since you closed on the loan, and now it’s about to adjust to 5%, thereby increasing your monthly payment to $1,610—a significant jump of $345 per month,” says Tim Choate, founder/CEO of RedAwning.com. “However, let’s imagine you could refinance into a new 30-year fixed-rate loan at 4%. That means your payment would be approximately $1,432, saving you $178 each month compared to the adjusted ARM payment.”

Or, using more realistic current rates as a barometer, suppose your $300,000 5/1 ARM is adjusting to 7%, but you have an opportunity to refi to a fixed-rate loan at 6%. In this scenario, your monthly payment would stabilize at $1,798 versus $1,995 or higher if you stuck with the ARM.

“The main benefit here is that your rate will stay the same for the entire length of your new refinance loan, with no adjustments,” says Lokenauth. “These fixed housing payments provide real peace of mind.”

On the downside, the locked-in rate for a new fixed-rate loan could be higher than the initial rate you pay for an ARM (whether it’s your current ARM that hasn’t yet adjusted or a new ARM you refinance into). But over the life of the loan, you could pay a lot less in total interest for a fixed-rate loan than an adjustable ARM, although there’s no guarantee: ARM rates can also adjust downward, providing the potential to save more money than a fixed-rate loan would.

In addition, as is true of any refinance option, you’ll pay closing costs (more details to come) by switching from an ARM to a fixed-rate home loan.

How to Refinance into a Fixed-Rate

Determined to claim the surety of an unchanging mortgage rate? Here are the steps for refinancing into a new fixed-rate mortgage loan:

1. Assess your financial goals and timeline for paying off a new loan.
2. Review your credit reports and credit score, and try to up your score to land a better loan offer.
3. Gather the necessary documents – including proof of income, tax returns, and credit reports.
4. Shop around among multiple lenders and request rate quotes and loan offers.
5. Compare each loan offer carefully – sizing up the rates, terms, and closing costs – to find the best deal.
6. Choose the right loan offer and term, apply for the loan, and lock in your rate.
7. Have your home professionally appraised (if required by the lender) to determine its value.
8. Await an underwriting decision.
9. Review the loan details and terms carefully at closing, sign the required paperwork, and pay closing expenses.

Reasons to Refinance into Another ARM

Just because your current ARM holds some uncertainty due to its rate changeability, that doesn’t necessarily mean you should only consider refinancing into a new fixed-rate loan. The experts suggest giving careful thought to resetting matters with a fresh ARM.

“Refinancing into another ARM can be beneficial if you are planning to sell or refinance again within the next few years,” adds Holman. “For example, if your current ARM is adjusting to 6.5%, and you can refinance into a new 5/1 ARM at 5%, this could save you thousands during the new ARM’s initial fixed-rate period, which will last five years. If you sell your home before the end of the five years, this option makes sense.”

Or, perhaps you anticipate that rates will remain stable or drop in the foreseeable future. If so, refinancing to a new ARM could be a wise choice. You could also opt for an ARM with a longer initial fixed-rate period and further postpone any nervousness about your rate adjusting.

“Assume you switch from a 5/1 ARM at 4% to a new 7/1 ARM at 3.5% on a $300,000 loan. This would reduce your monthly payment from about $1,432 to $1,347, saving you $85 monthly,” Choate says.

Of course, this route is a bit of a gamble, as your new ARM will eventually adjust, possibly sending rates higher.

“If rates rise significantly after the adjustment, you could face much higher payments down the line. It’s a calculated risk that depends on your financial goals and market outlook,” cautions Choate.

In addition, don’t forget that a refi to a new ARM will incur unavoidable closing expenses.

How to Refinance an ARM into Another ARM

When the time is right to pull the trigger on a refi into a new ARM, prepare to complete these steps:

1. Evaluate your financial objectives and determine your timeline for repaying a new loan.
2. Check your credit reports and credit score, and work to improve your score to secure a better loan deal.
3. Collect all required documents, such as proof of income, tax returns, and credit reports.
4. Research and compare multiple lenders, requesting rate quotes and loan options from each.
5. Analyze each loan offer thoroughly, considering interest rates, terms, and closing costs to select the best option.
6. Decide on the most suitable loan and term, then formally apply and lock in your interest rate.
7. Have your home professionally appraised (if the lender requires this) to establish its value.
8. Wait for the lender’s underwriting decision.
9. At closing, carefully review the loan terms and details before signing the necessary documents and paying closing costs.

When Can You Refinance an ARM and What’s Required?

Keep in mind that most lenders require your existing ARM to be seasoned before refinancing. In many cases, you have to wait at least six months after closing on your original loan, although some lenders may permit a refinance sooner, while others could require waiting up to 12 months. Inquire with your new desired lender about their rules.

“This waiting period allows the lender to assess your payment history and ensure it’s consistent and timely. Making payments as agreed upon for at least six months establishes that good pattern,” Lokenauth points out.

Also, check to see if any prepayment penalties exist in your current mortgage loan agreement, as these could affect the cost-effectiveness of refinancing early.

To qualify for a refinance of your ARM, expect to meet minimum lender requirements. Aim for these benchmarks:

• Credit score: 620 or higher (700 or higher for the best rates)
• Debt-to-income (DTI) ratio: 43% or lower
• Loan-to-value (LTV) ratio: 80% or lower
• Loan seasoning: Usually 6 months minimum
• Employment history: Stable employment and/or consistent income sources
• Cash reserves: Your lender may require that you have enough saved to cover a few months of mortgage payments.

Refinance Costs to Consider

Make no mistake: you’ll have to pay your share of closing costs whether you refinance into a new ARM or a new fixed-rate mortgage loan.

“Closing costs usually range from 2% to 5% of the loan amount. These costs may include application and origination fees, appraisal fees, title insurance expenses, attorney fees, recording fees, and taxes,” says Holman. “For a $300,000 loan, for example, you can expect to pay $6,000 to $15,000 in closing costs. The good news is that many lenders offer no-closing-cost options by rolling the closing costs into your loan via a slightly higher rate.”

Also, assuming you can lower your monthly payments by refinancing, bear in mind that you’ll likely recoup the closing expenses you pay after you break even. Breaking even on refinance closing costs refers to when the savings from a new loan—usually through a lower interest rate or reduced monthly payments—match the upfront expenses paid to finalize the loan. Beyond this point, the financial benefits of the loan exceed its initial costs. Case in point, if you refinance your ARM and incur $6,000 in closing costs to obtain a lower interest rate that saves you $200 per month, your break-even point would be 30 months.

The Bottom Line

Fortunately, you’re not tethered to your current ARM: you can choose to refinance when the time is right, and, ideally, you can save money by shifting to either a fresh ARM or a new fixed-rate mortgage loan with a lower rate and better terms.

But you’ll need to do your homework and forecast future needs carefully to determine which option best suits your situation. Before committing to a new financing offer, think hard about how long you plan to remain in your home, your future job and earning prospects, and where you believe the rate climate is heading.