2 Reasons To Refinance An ARM When Interest Rates Fall

Refinancing an ARM when the Cap Limit Is More Than Current Interest Rates

All good adjustable rate mortgage is come with a limit on the interest-rate. This is known as a Cap.

This is an interesting point of view which many people with adjustable-rate mortgages do not consider. Someone with a fixed-rate mortgage has no option but to refinance in order to take advantage of lower interest rate. People with adjustable-rate mortgages think that since there interest rate adjusts to the market rates anyway, they do not have to refinance when the interest rate for.

However, the one thing that borrows of adjustable rate mortgage is to not consider is that just like there is a limit on how much the interest rate can increase in a year, there is a similar limit on how much an ARM interest can decrease.

Let’s say that the interest rates decreased by 2%. You get notified by your lender that you’re monthly payment is going to come down to 1% since that is the maximum allowable limit that the interest rate on your adjustable rate mortgage can decrease in any given year.

This means that you cannot fully take advantage of the market rate and will have to wait for next year for the rate to decrease by another 1% but only if the low interest rates that are floating around today are still there.

You may console yourself by thinking that this is all right since your limit on the interest rate protects you both ways. If you cannot take full advantage of lower interest rate in the market, similarly you don’t get overly penalized by the interest rates go up either.

But imagine this scenario. Since interest rates have fallen, a new borrower can get the same adjustable rate mortgage as yours at 4.5% today. You, however, got your mortgage at 6.5%. This means that you will have to wait for two years before your interest rate can come down to the rate that is active today and that is also providing that the low interest rate continues to hold.

But if you were to refinance today at 4.5%, even if interest rates were to increase in the future and your rate would increase for 2% which is the worst-case scenario as allowed by the yearly limit on interest-rate increase, it would still be paying 6.5% which is what you’re paying today anyway.

Refinancing an ARM to Reduce Maximum Lifetime Interest Rate Cap

Another very interesting aspect to consider about refinancing an adjustable rate mortgage is that by refinancing to a lower interest rate today than what you originally got, you are bringing down the maximum ceiling on your ARM, adjustable rate mortgage.

All good adjustable rate mortgage come with a maximum ceiling on loans which is the maximum that the interest rate is allowed to increase throughout the life of the loan. This is in addition to the yearly limit which is how much the rate can increase in any given one year.

Let us consider an example where you took out your adjustable rate mortgage for 6.5% that comes with a maximum limit of 6%. This means that in the worst-case scenario, where the interest rate on your mortgage reaches its maximum, you could be a 12.5% on your mortgage loan.

However, if you were to refinance today to a lower interest rate of 4.5% of that same adjustable rate mortgage, you bring down the maximum interest rate to 10.5%.

Since the maximum limit on your adjustable rate mortgage is 6%, your adjustable rate mortgage is only allowed to increase up to that limit during its entire term which gives us 6% +4.5% that you qualify for today which equals to 10.5% as opposed to 12.5% of interest in the worst-case scenario. In this manner refinancing your adjustable rate mortgage can not only reduce the monthly payment but it can also cut down on the maximum risk that you face on the mortgage.