Time to refinance ARM?

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Dear Dr. Don,
I am in the fortunate position to have my mortgage as my only debt. I am religious about maxing out my Roth IRA every year, and since I am a firefighter, I also have a pension. I also am able to put extra money into savings.

I purchased a condo in March 2005 and opened up a 5/1 adjustable-rate mortgage. The initial rate will expire in March 2010 and the loan will reset every year to the one-year London Interbank Offered Rate, or LIBOR, plus 2.25 percent.

The current one-year LIBOR rate is 1.5 percent, so I would be getting a year at a very low rate. Do you think I should try and wait or look to refinance? Even with the low housing market, I will still have 20 percent equity and my credit score is over 800. Also, I am able to afford a 15-year mortgage. Would that be the loan to refinance to? Or stick with a 30-year? I am unsure as to how much longer I will live here, probably a few more years.
— Tom Turnover

Dear Tom,
It certainly sounds like you have your ducks in a row and are working toward your financial goals. The decision to refinance your condo should have the goal of minimizing the total interest expense on the loan during the time you’re in the loan.

If you’re a short-timer in the condo, you’re less worried about interest rates headed higher than the homeowner who plans on being in the loan for a dozen or more years. The closing costs associated with a new first mortgage are likely to outstrip any potential interest rate risk over the short term, which I’ll define as one to three years.

Bankrate tracks LIBOR on its rate watch page, “LIBOR, other interest rate indexes.” You’ll be able to keep your finger on the pulse as to where this rate is going by bookmarking this page. Bankrate also has an adjustable-rate mortgage calculator that will calculate the new payment on an adjustable-rate loan.

If you only plan on being in the condo for another one to three years, you should be able to accept the interest rate risk of rising LIBOR rates. You don’t need to worry about accelerating the loan payoff by switching to a 15-year loan from your current financing.

The Mortgage Professor’s Web site has a calculator, “Refinancing an ARM into an FRM,” that allows you to run interest rate scenarios to compare the ARM with a fixed-rate loan.

Read more Dr. Don columns for additional personal finance advice.