Major Factors to Calculate Before Refinancing
There are other major factors to calculate into the decision to refinance an ARM (Adjustable Rate Mortgage) into a FRM (Fixed Rate Mortgage):
Time Horizon. In general, the longer the borrower expects to remain in the house, the stronger the case for the refinance. More bad things can happen to the ARM over a longer period.
ARM Features. Refinance is a less attractive option for ARMs with particularly desirable features. These include a low current rate, a long period to the next rate adjustment, a low rate adjustment cap, a low maximum rate and a small margin.
(Note: If your credit score has improved since you took out your mortgage, you may be able to refinance to an ARM with a lower margin and save. This is because the size of the margin—the amount that’s added onto a specific index to calculate the interest rate you’re charged—is partly based on the credit score you have at the time you apply for a mortgage. A better credit score can mean a lower margin and lower interest payments. The margin is added to the rate index to determine the new rate on an adjustment date, subject to the adjustment cap and maximum rate.)
FRM Features. The rate on the new FRM will be higher than the ARM rate, but much depends on how much higher it is. Consideration must be taken of refinance costs, including points, other lender fees and other settlement costs, all of which reduce the benefit of a refinance.
Prepayment Penalty. A prepayment penalty on the ARM acts just like an additional fee on the FRM, since you only pay it if you refinance.
Mortgage Insurance. If the borrower is paying for mortgage insurance on the ARM but the house has since appreciated, the FRM might not require the insurance. Even if it is required, the premiums on FRMs are lower. This would be a partial offset to the costs of the FRM.
Assumptions about Future Interest Rates. A critical factor affecting the decision you make to refinance or not, is the assumption you make about future interest rates.
