Refinancing out of an adjustable-rate mortgage (ARM) -- Page 2

If rates settle down, van Wyk wouldn't mind going back to a LIBOR-indexed mortgage. But he doesn't want to stick with one while rates are rising.

Experts: Rates will rise
And rates are expected to keep going up. The Mortgage Bankers Association's forecast calls for mortgage rates to rise about three-quarters of a percentage point the rest of the year.

The MBA tracks mortgage applications, measuring the proportion of borrowers who are refinancing their loans (38.3 percent the first week of April) and the proportion who are opting for ARMs (35.2 percent the first week of April). But the MBA doesn't track what kind of loans refinancers are getting out of and getting into.

However, says Michael Fratantoni, MBA's senior director for single-family research, one can make educated guesses. Hybrid ARMs, in which the initial interest rate stays the same for three or more years, are increasingly popular. The inference is that a lot of people are refinancing into hybrid ARMs.

Bob Moulton, president of Americana Mortgage in New York, has a customer who just switched to a 30-year fixed from a 5/1 ARM, the most popular of the hybrid adjustables. A 5/1 ARM keeps its initial rate for five years, then adjusts annually.

Moulton's client got a 5/1 ARM at 5.125 percent a year ago "because they were planning on staying in the house for a five-year period." But now, he says, "they realize they're going to be there longer than they first anticipated."

Stability's a draw for fixed rates
"He and his wife were concerned about rates going up in the future and they want to have the stability of a 30-year fixed rate. So he refinanced and we put him in a 30-year conforming (mortgage) at 5.5 percent at no points." Moulton persuaded his client to lock in February, at the bottom of a rate dip. Rates went up soon after.

Moulton steadfastly declines to forecast rates, especially in the long term. His client looked at what would happen if rates continue to climb. His rate could go into the double digits in four years. He decided he would rather pay about $4,000 in closing costs to get a fixed-rate mortgage and eliminate that possibility. The monthly payments are roughly $100 higher with the fixed-rate loan -- about $5,000 over the next four years.

With the closing costs and higher monthly payments, Moulton's client is paying about $9,000 over the next four years to insure himself against the unsure possibility that the rate on his former 5/1 ARM will skyrocket in 2009. He is betting, then, that two things will happen: Adjustable rates will rise, and he will remain in his house for years. "If you're moving soon, I wouldn't do it," Moulton says.

How long will you own it?
Length of ownership seems to be the most-common deciding factor when people switch from ARMs to higher-rate fixed-rate loans. That was the case for Pat and Karen Morrison of Weston, Fla., whose situation is similar to that of the van Wyks. The Morrisons married 18 months ago and their first child is due in June. Last June they moved to a bigger, one-story house. They kept their two-story townhouse and they rent it out.

They took out a one-month LIBOR on 80 percent of the house's price. The low monthly payments on the house allowed them to keep the townhouse. The rent they collect is about $200 less than it costs to keep and maintain the townhouse, but they estimate that the townhouse's value is rising by about $3,000 a month. This is, after all, South Florida, where real estate values are skyrocketing.

Something unexpected happened after they moved into their house. They fell in love with it. "Basically, we think we're set," Pat Morrison says. "We were thinking about it short term, but now we're thinking of living here long term." And by long term, he means decades. "Now that we've lived here, we're thinking of retiring here."

Eventually, they might sell the townhouse and use the proceeds to pay off the home equity line of credit they took out in lieu of a 20 percent down payment on the house. Or they might keep the townhouse, especially if they can raise the rent enough to generate positive cash flow.

They figure that if they're going to keep the house into retirement, they might as well fix the mortgage rate. They locked recently with their current lender, Homebanc, at 6.125 percent. The closing costs will run about $4,000.

The way Morrison looks at it, he would have paid a higher rate -- about 6.25 percent -- if he had got a 30-year fixed last June. Now he's grabbing a lower rate than he would have got last June, and in the meantime he saved enough money with the one-month LIBOR to offset the closing costs on the refinance.

"It wasn't a bad gamble, I guess," Morrison says. "At least it paid for itself."