Does Your Adjustable Rate Mortgage Still Make Sense? Adjustable rate mortgages (ARMs) became very popular a few years ago (especially 2002 to 2005) because ARM interest rates, and resulting monthly payments, were significantly less than those found with traditional 30-year fixed rate mortgages. Arms typically have 30 a year amortization schedule and an interest rate that can be adjusted after an initial rate period based on some interest rate index. The chart below shows how the spread between 1-Year ARM rates and 30-year fixed mortgage rates was as much as 2 full percentage points several years ago. That spread has shrunk considerably. In July, 2003, a $250,000 ARM offered rates and payments much lower than a 30-year fixed rate mortgage. January 2011 $250,000 Mortgage Rate Comparison Mortgage type Interest rate Monthly payment 30-year fixed 4.86% $1,320.75 1-year ARM 3.26% $1,089.39 If you currently have an adjustable rate mortgage, there are two questions to consider: What will happen to your monthly payments if your ARM interest rate rises? Should you consider refinancing into a fixed rate or other type of mortgage? Analyzing the impact of a future increase in an adjustable rate mortgage interest rate Current Adjustable Rate Mortgage Your loan amount $ Your interest rate % Amortization period 30 years 20 years 15 years Monthly payment $ Understand what can happen If the interest rate is adjusted upward by: 1% 2% 3% New interest rate New monthly payment Increase in monthly payment Interest is compounded monthly. This calculator is to be used for estimation purposes only. The financial institution is not responsible for its accuracy and the results are not guaranteed. Consider Refinancing As part of this review, be sure to include several factors: Interest rates - How does your current rate compare with those currently available? Type of mortgage - Does your mortgage type (fixed or adjustable rate) fit your plans on how long you intend to live in your current home? Monthly payments - Can you reduce your payments by refinancing or can you afford more? Loan balance - If you have paid down your mortgage over time, refinancing the lower balance may reduce your payments even with the same interest rate. Do you wish to refinance with a higher balance to access equity you have built up to pay down other loans or for other purposes? Costs of refinancing - You may incur expenses when you refinance. If refinancing with lower monthly payments is your objective, you should be sure that your monthly savings over a short period of time will offset any refinancing costs you may have. Tax consequences - Interest paid on a home mortgage is usually tax deductible for those that itemize their deductions. Consult your tax advisor for more information. Here is a calculator that will help you determine monthly payment levels with different types of mortgages. Mortgage Comparison Calculator Current mortgage balance or amount you are considering refinancing $ Fixed Rate Mortgage Alternatives Interest rates (assumes amortization over the term of the loan) 30 year fixed % 20 year fixed % 15 year fixed % Adjustable Rate Mortgage Alternatives (Arms) Interest rates (assumes 30 year amortization) 1 year ARM % 3 year ARM % 5 year ARM % 7 year ARM % 10 year ARM % Balloon Mortgage Alternatives Interest rates (assumes 30 year amortization) 7 year balloon % 10 year balloon % Results Monthly payment levels Fixed rate mortgages 30 year fixed 20 year fixed 15 year fixed Adjustable rate mortgages 1 year ARM 3 year ARM 5 year ARM 7 year ARM 10 year ARM Balloon mortgages 7 year balloon 10 year balloon Interest is compounded monthly. This calculator is to be used for estimation purposes only. The financial institution is not responsible for its accuracy and the results are not guaranteed Consider the Costs of Refinancing As you analyze your refinancing options, be sure to factor in all of the costs that may be associated with the refinancing. You should recover those costs over a relatively short period with lower monthly mortgage payments. Here is a worksheet that will help. How long will it take to recover your refinancing costs? Your current monthly mortgage payment $ Your anticipated new monthly mortgage payment $ Costs you may incur when you refinance Discount points $ Title search fee $ Origination points $ Title insurance fee $ Application fee $ Appraisal fee $ Credit check fee $ Inspections $ Your attorney fees $ Local fees and taxes $ Lender attorney fees $ Other fees $ Estimated costs of refinancing Monthly savings from reduced mortgage payment reduction Months to recover your refinancing costs Interest is compounded monthly. This calculator is to be used for estimation purposes only. The financial institution is not responsible for its accuracy and the results are not guaranteed. Other Issues to Consider The size of your mortgage payment should only be one part of your mortgage decision making process. If "paying off" your mortgage or significantly reducing your total debt level is important, a shorter term fixed rate mortgage with a 20 or 15 year term may be right for you. If you plan to live in your home for only a short time (for example, five years or less), you may want to seriously consider an adjustable rate mortgage with an initial rate term that matches your moving plans. Balloon mortgages are usually less attractive than a similar term ARM. With a balloon mortgage, you will need to secure a new mortgage at the end of the term subjecting you to not only to changes in rates, but also the costs and process of getting that new mortgage. Be sure that you can afford your mortgage payments - both at the time you get it and in the event that you get an ARM and rates have risen when the initial rate period expires. Summary Choosing the mortgage that is right for you is critical. Consider what you want your mortgage to do for you. Factor in your plans for how long you anticipate needing the mortgage (how long you are going to live in the home) and be sure that you can accept the risk that your monthly payments may rise if you choose an adjustable rate or balloon mortgage.