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Dr. Don Taylor, CFA, advice columnistTo refinance or not to refinance

Dear Dr. Don,
I have a 5/1 ARM with an interest rate of 4.5 percent. The five-year lock ends in June 2009. It can go up 2 percent per year after that but can't reach a total higher than 9.99 percent. Based on the rising rates lately, should I worry and refinance right now or ride it out until then and see what happens?

-- Thomas Turnover

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Dear Thomas,
The decision to refinance out of your 5/1 adjustable-rate mortgage into fixed-rate product depends on how long you plan on being in the house, your attitude toward risk and your outlook on interest rates. If this is a starter home or you plan to downsize in the next three to five years, then staying in a 4.5 percent loan over the next three years makes perfect sense. If you don't ever plan on moving, then you need to at least consider refinancing while 30-year fixed rates are still under 7 percent.

If your mortgage has an annual cap of 2 percent and a lifetime cap of 9.99 percent, it would be at least 2010 before your mortgage rate could hit 8.5 percent. While that's about 1.75 percent higher than current 30-year fixed-rate mortgages, you're not paying any refinancing costs or expenses to stay in your current loan. What's the worst that can happen? Your loan could go to 9.99 percent in 2011 and stay there for the rest of the loan term. That's not inconsequential but isn't relevant if you don't plan on staying in the house.

It's a rough approximation, but if your loan balance is currently $100,000, refinancing a 4.5 percent loan three years before it becomes an 8.5 percent loan costs you $8,000 per year over the next three years. That's $24,000 plus closing costs. Refinancing today at 7 percent will cost you an additional $7,500 over the next three years, versus the existing mortgage, plus closing costs. The interest expense is scalable, so a $200,000 loan balance would be twice as much plus closing costs.

The Federal Reserve just raised its target for federal funds a quarter point to 5.25 percent, the 17th consecutive quarter-point move since its June meeting in 2004. The prime rate followed suit to 8.25 percent, but the 10-year Treasury note is still under 5.25 percent -- at 5.17 percent as I write this reply. Keep an eye on the 10-year Treasury note, because it's used as the benchmark in pricing fixed-rate mortgages. It's been in a range from 4.75 percent to 5.25 percent since March of 2006. You can follow the 10-year constant maturity on Bankrate using its rate watch feature.

Bottom line, if you're not in this house for the long term, don't get overly concerned about refinancing your 5/1 ARM.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."'s corrections policy -- Posted: July 12, 2006
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