Refinancing an Adjustable Rate Mortgage
An adjustable rate mortgage's interest varies according to how interest rates are doing in general.
The periodic rate cap keeps your interest rate from increasing too rapidly. However, the periodic
rate cap works both ways, and also keeps your interest rate from dropping too fast. Since the
interest rate on your loan doesn't fall as fast as market interest rates, you could be in a
position where you have a higher interest rate compared to other interest rates available.
There are two options available, one is to keep your adjustable rate mortgage, and wait for
the interest rate on it to drop. While you are waiting for them to drop, you will be paying
a higher interest rate than a newer loan. The second option is refinancing your adjustable
rate mortgage. By refinancing you will be able to obtain the lower interest rates immediately,
however it will still cost you in refinancing fees.
For example if your adjustable rate mortgage is at 9%, with a ± 2% periodic rate cap per year
and adjusts to 7% at the end of the year. Then if the market rate has dropped to 4%, even with another adjustment that still puts your interest rate 1% higher than the market rate.
By refinancing you can save money on your monthly payments sooner than waiting for your
interest rate to decline.
Another reason to refinance your adjustable rate mortgage is to reset the lifetime interest
rate cap. The lifetime interest rate cap is the highest your interest rate can go over the
life of the loan. If you refinance and reset the lifetime cap, then you would have limited
your risk of higher interest rates if they rise in the future.
For example if your adjustable rate mortgage is currently at 9%, and your lifetime rate cap
is 12%, then your interest rate can never exceed 12%. However, if a loan is being offered with
a lower lifetime cap say 10%, then by refinancing you can limit the risk of rising interest
rates in the future.
If you decide to refinance your adjustable rate mortgage, you could choose to switch it to
a fixed rate mortgage. By switching to a fixed rate mortgage you eliminate any uncertainty
about rising or falling interest rates. The switch, however, will not only cost you in refinancing loan fees, but also a fixed rate mortgage will generally have a higher interest rate than your current adjustable rate mortgage. The higher interest rate and thus the higher monthly payment is the price of eliminating the uncertainty of your adjustable rate mortgage.
Refinancing an adjustable rate mortgage can lower your interest rate, that would normally
take several periodic rate adjustments to occur. The refinance can also be helpful in
resetting your adjustable rate mortgage's lifetime rate cap. You can also decide to eliminate
future risk of rising rates by refinancing to a fixed rate mortgage. Be sure to talk to your
lender about all the options available before making a decision.
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