Refinance Rumors

"Always go with a fixed rate mortgage (FRM)"

The other day, Roxanne approached me saying that she was going to refinance to a 20 year FRM. When she told me that she only planned on staying in the house for about 5 more years, I was shocked. "Have you considered refinancing to an adjustable rate mortgage?," I asked.

She told me that her husband thinks ARMs are too risky and that he heard that he should always go with a fixed rate mortgage. I explained that the decision to choose between an ARM or FRM really depends upon the circumstances and that sometimes an ARM really can be the right type of loan to refinance to.

For her situation, I recommended checking the rates of a 5/1 ARM, meaning that the mortgage would remain fixed for 5 years and then adjust annually for the remainder of the term. My reasoning behind it is that the beginning fixed rate of a 5/1 adjustable rate mortgage will be lower than the rate you would get for a fixed rate mortgage. By the time the loan rates start adjusting, she would be ready to sell.

There is always that chance that she won't be able to sell or will change her mind about selling and will have to stay with that ARM. When making this decision one should perform the Scenario Analysis, discussed by mortgage professor, Jack Guttentag, in "Choosing Between Fixed & Adjustable Rate Mortgages", to be aware of the best and worst case of a particular ARM.

If you are looking into refinancing, don't go by hearsay and don't listen to anyone that tells you to always go with a fixed rate mortgage. Performing the proper research is key to making the right decisions. Checking the various possible scenarios is the best way to eliminate risk and save money when refinancing.

"But If I refinance, it will extend the term of my loan."

Another rumor floating around is that refinancing will add to the amount of time it will take to pay off the loan. For example, my friend George said to me, "I want to refinance and have been paying off my original 30 year home mortgage for 6 years. Does refinancing mean that I'll be paying off the loan for another 30 years?"

I explained to George that it could be possible to find a 20-year refinance option with a low enough interest rate and costs, while only having to make payments for those 20 years. Additionally, one can pay off a 30-year mortgage by increasing payments so that it is paid off in the desired amount of time. The mortgage professor also addresses a similar circumstance in his article, "Refinance a Mortgage Without Extending the Term?".