||Ask Dr. Don
Should I refinance now or later?
Dear Dr. Don,
I have an ARM (adjustable-rate mortgage) at 6.375
percent that will go up in October 2004 to 7.375 percent. If I refinance
before October it will cost me $7,540 in penalties. I have an offer
of a 5.625 percent 30-year fixed rate on a $385,000 loan. I plan on
staying in my home for at least 10 years. With rising interest rates,
should I pay the penalty or wait until October to refinance on the
chance that the rates will be higher?
Chances are good that short-term rates will be higher in October.
There are three meetings of the Federal Open Market Committee between
now and then, and odds are that the committee will decide to raise
the targeted fed funds rate at one of those meetings. Whether that
action translates into higher interest rates for 30-year fixed-rate
mortgages isn't as clear cut, but it's not likely that you'll be
able to get a 30-year fixed-rate mortgage at a rate lower than the
5.625 percent you're being shown now.
Getting out of an ARM before short-term rates start
heading higher can make a lot of sense, especially if you plan on
being in the home for the next 10 years. Refinancing using a 10/1
ARM is a compromise that may allow you to capture a slightly lower
interest rate than the 30-year fixed rate.
The table below is a rough estimate of the risks you face by waiting
to refinance in October. I didn't consider closing costs because
you're paying closing costs whether you refinance now or in October.
Waiting until October costs you about $4,800 for every
one-eighth of a percentage point increase in interest rates. Rates
would have to increase by less than one-quarter of a percentage
point for you to break even on your prepayment penalty. Use Bankrate's
mortgage calculator with its amortization schedule, like I did,
if you need to create your own table.
Between the certainty of an increased ARM rate and
the probability of higher fixed rates in the fall, it makes sense
to refinance now. I'll be the first to tell you that I don't know
where interest rates will be in October, but they don't have to
move much higher for you to be better off paying the prepayment
penalty and capturing the current rate.
-- Posted: June 17, 2004