Dear Dr. Don,

I bought my house in July 2008 for $395,000 with a 5/1 adjustable-rate mortgage at 5.125 percent that expires three years from now. My property price has dropped from $395,000 to $345,000 over this time period. I am planning to refinance at 3.25 percent using a 7/1 ARM with no closing costs.

My lender says I need to have a 90/10 loan to value. My present loan balance is $328,000. So if I want to refinance, I’ll need to bring $18,000 in cash to closing to reduce the loan amount to $310,500. What is your suggestion?

— CS Closings

Dear CS,

First figure out if you’ll be paying private mortgage insurance, or PMI, on the 90 percent loan-to-value, or LTV, mortgage and the dollar amount of that payment. Conventional mortgages require PMI when the LTV is more than 80 percent.

I used a couple of online PMI calculators and came up with an average estimated monthly PMI payment of $147 per month. The PMI requirement won’t last over the entire term of the mortgage, but it lessens your savings from refinancing, especially if you weren’t paying PMI on the original mortgage.

Next, keep in mind there’s really no such thing as a no-cost closing. The closing costs are either added to the loan balance or incorporated into the mortgage rate. Figure out which is true in your case. You may be better off paying the closing costs rather than financing them.

Third, estimate how long you plan to be in the home. Mortgage rates are at record lows. The 7/1 ARM you’ve cited has a great fixed rate over the next seven years. But if you expect to be in the house for the long haul, a 30-year fixed at the recent Bankrate national average of 4.54 percent may be the better long-term choice. Who knows where mortgage rates will be seven years from now?

Last, make sure you know the underlying interest rate and the pricing spread that will be used when the loan first resets seven years from now. Understand any lifetime caps, floors and maximum changes on the reset for the loan. You don’t want to feel trapped seven years from now as you look for the third mortgage financing in the nine years that you’ve owned this home.

I know I’ve painted a somewhat negative picture here on your proposed refinancing. Replacing your 5/1 ARM with a 7/1 ARM can make perfect sense if you’re fairly confident you’ll only be in the house seven more years.

The refinance calculators don’t work all that well for these hybrid mortgages because you wind up either assuming the initial rate stays in place over the life of the loan, or you forecast (guess) which way interest rates will trend over the loan term.

Assuming you can afford it, I don’t have an issue with a cash-in refinancing. In fact, they’re becoming quite common in mortgage refinancings. The Bankrate feature “‘Cash-in’ refinance activity skyrockets” discusses the trend.

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