refinance

Who should refinance into an ARM?

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Highlights
  • Initial interest rates on ARMs are lower than for fixed-rate mortgages.
  • Despite lower payments on ARMs, most refinancers prefer fixed-rate loans.
  • ARMs appeal to jumbo borrowers and those who will sell within a few years.

Low mortgage rates have many homeowners rushing to refinance, and the vast majority of those borrowers opt for fixed-rate home loans. Yet for some homeowners, an adjustable-rate mortgage can be a financially savvy choice when they refinance.

Nowadays, adjustable-rate mortgages, or ARMs, appeal to two groups of borrowers. The first group consists of homeowners who need jumbo loans, above the conforming loan limit of $417,000 in most markets and $625,500 in high-cost housing markets. Many of these borrowers want to keep their payments as low as possible when they refinance, so they're attracted to lower-rate ARMs. The second group comprises homeowners who have firm plans to sell their homes in a few years because of scheduled job transfers or retirement.

"The people who are most interested in ARMs tend to have a jumbo loan, but we also see people who know they will sell their home within a few years," says Bill Kusman, president of mortgages for First Bank, in St. Louis.

If your goal is to keep your monthly payments as low as possible and you have a specific time frame for selling your property, an ARM might be the best refinance option. But if the goal is to pay down the loan quickly or to avoid the risk of rising monthly payments in the future, then a fixed-rate loan might be a better refinance option.

The initial rate on an adjustable-rate mortgage tends to be lower than on a fixed-rate mortgage. In the third quarter of 2011, the rate on the 5/1 ARM averaged 3.21 percent in Bankrate's weekly survey; the average rate on the 30-year fixed-rate mortgage was 4.49 percent. On a $100,000 loan at those rates, the principal and interest on the ARM would be $73 less each month.

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Despite the higher initial payments, about 93 percent of refinance applications in September were for fixed-rate mortgages, and 7 percent were for ARMs, according to the Mortgage Bankers Association. Michael Jablonski, executive vice president and mortgage retail production manager for BB&T Bank in Wilson, N.C., says ARM applications are relatively rare because borrowers generally want to lock in a fixed rate when mortgage rates are historically low.

"Uncertainty about their income, expenses, taxes and the economy have led people to gravitate to fixed-rate mortgages just so that they have one thing that they have certainty about," Jablonski says.

Jablonski says even homeowners who are fairly certain about their plans to sell their home for a job transfer or retirement often choose a fixed-rate mortgage because they recognize they may not be able to sell their home right away.

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