Some Borrowers Should Refinance and
Some Should Not
Borrowers with an ARM can find themselves in any of four possible situations:
- Both the ARM (Adjustable Rate Mortgage) Rate and the FIR (Fully-Indexed Rate) Are Higher Than the FRM (Fixed Rate Mortgage) Rate. This means that the borrower would profit from refinancing immediately. He would also profit after the next ARM rate adjustment unless the index fell by enough to bring the new ARM rate below the FRM rate. Case for refinance: Very strong.
- Both the ARM Rate and the FIR Are Below the FRM Rate. This means that refinancing is a loser now, and will to be a loser after the next ARM rate adjustment unless the index raised enough to bring the new ARM rate above the FRM rate. Case for refinance: Weak, except for the most risk adverse borrowers.
- The ARM Rate is Below While the FIR is Above the FRM Rate. This means that the borrower would lose money by refinancing the ARM now, but the situation will be reversed at the next ARM rate adjustment. Case for refinance: Strong, but unless the borrower is very risk adverse, it makes sense to wait until shortly before the next rate adjustment.
This is the most common situation. Some borrowers get spooked into hasty action by fear that rates will be higher in the future, which could happen; but rates could also be lower. Experts advise not to give up the clear benefit of holding the ARM until the rate adjusts unless the current FRM rate is about the maximum the borrower can afford. In that case, the reward from hanging onto the ARM until the rate adjusts is outweighed by the risk. - The ARM Rate is Above while the FIR is Below the FRM Rate. This means that the borrower would profit from refinancing the ARM now, but the situation will reverse itself after the next rate adjustment. It is clear that if the borrower refinances in this case, it should be done immediately. What is not clear is whether the short-term savings from getting rid of the high-priced ARM now justifies giving up a lower ARM rate in the future. And while the situation is uncommon today, it would quickly become common if rates begin another downward trend. Case for refinance: More calculation needed.
