Changing circumstances? Change your mortgage

It's a good idea to evaluate your mortgage periodically to figure out whether it still fits your circumstances.

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Do you have a 30-year fixed-rate mortgage, but plan to move within five years? Maybe you should get an adjustable-rate loan. Do you or your spouse plan to take unpaid parental leave in the next few months? Maybe you should think about changing that adjustable-rate loan to a fixed.

Bob Walters, senior vice president of Quicken Loans, recommends making a New Year's resolution to re-evaluate one's mortgage annually. He draws an analogy to investing for retirement.

"Just like different types of (investment) funds are appropriate in different times of your life, based on age and income and risk levels and goals, the same is true for mortgages," Walters says. "You have to use the same concept of, what they call in investing, 'rebalancing.' You have to take an annual look and ask, 'Do I have the right kind of mortgage for myself?'"

That's a question that only you can answer. Two homeowners in identical situations, but with differing temperaments, might feel comfortable with radically dissimilar mortgages. Mortgage lenders might offer different advice, too -- some belong to the risk-taking camp, and others counsel clients that it's better to be safe than sorry.

Walters believes that it's logical to take calculated risks, and that people should select their mortgages based on logic, not emotions. "A lot of people determine their mortgage based on fear," he says. "Because they come from a fearful approach -- 'Oh no, what would happen if interest rates rose? I've got to protect myself from that.' I think a lot of people never even ponder for a second the products outside a fixed-rate mortgage because of that."

He's mostly talking about adjustable-rate mortgages, or ARMs. Some of the most popular loans are hybrid ARMs, which have an introductory rate that lasts three, five or seven years, then adjusts annually after that. These are called 3/1, 5/1 and 7/1 ARMs, and the initial rates are always lower than those offered for fixed-rate mortgages. There also are interest-only mortgages, in which the borrower pays only the interest and not principal. All interest-only loans are adjustable.

Risk of ARMs
An ARM can be riskier than a fixed-rate loan because its rate can rise after the adjustment period begins. If the ARM rate rises enough, the monthly payments can exceed those for a fixed-rate loan of the same amount. In exchange for that risk, the borrower enjoys lower monthly payments for a time.

Homeowners periodically should consider their loan options "even if just to ponder it," Walters says. "They can always crawl into their shell and pick the fixed rate. But they should think about it first."

And they shouldn't think about it only when they buy the house or refinance the loan to get a lower rate. Homeowners should consider their loan options whenever their circumstances change, Walters says. He offers a hypothetical example of a risk-averse homeowner who gets a 30-year fixed loan. Later, her boss tells her that she's on the fast track for a promotion, which will entail relocating within three years. That homeowner should refinance to a 3/1 ARM and reduce her interest rate by at least a percentage point, Walters says.

On the other hand, a married couple with a 3/1 ARM and a child on the way might want to switch to a fixed-rate mortgage if one of the parents plans to quit or take an extended leave from work. The monthly payment will be higher with the fixed-rate loan, but it will then stay the same if interest rates rise a few years down the road.