Just about everyone who comes into my office asks the same question. When I refinance, should I get a fixed or adjustable rate mortgage?

Since your home is about the most significant and important purchase you will make, that is a reasonable question to ask.

At first glance, fixed-rate mortgages seem like the best all around choice for most homeowners. Without fail you know what your payment is for the next 15, 20 or 30 years depending on the term of your loan.

But wait…. is it the best choice for you?

When you refinance, a fixed-rate loan may eliminate the risk of a rate increase down the road but that benefit can make a significant difference in your interest rate and payment amount. Homeowners who refinance with long term fixed rates pay between 1.00-2.00% higher than those who refinance with an ARM.

Homeowners who refinance to an adjustable rate mortgages may save thousands of dollars in interest and refinancing fees. Often times it’s a buyers only option to purchase a home.

The basics of an ARM (adjustable rate mortgage) are the same. You have a start rate which is lower than a fixed rate. At specified intervals your rate/payment will adjust up or down depending on the market and the specifics of your ARM plan. The majority of ARM plans have a cap on how much your rate/payment can be raised at specified intervals and over the life of the loan.

Look closely at the details of your ARM plan.

Let’s say for example, after you refinance, your loan amount is $100,000, your starting interest rate is 1.25%, the term on your loan is 30 years and your starting payment is $333.25 per month.

Let’s also assume your payment is fixed at that rate for 12 months and the worst case is that your payment may increase 7.5% of your payment amount. A little quick math will tell you that the maximum amount your new payment will be starting on the 13th month would be $358.24. That’s an increase of only $24.99 per month. Does that payment increase present a problem for you?

While this scenario is an over simplification of how an ARM loan works, the point I’m trying to make here is to figure out what the worst case scenario is for EACH of the maximum changes possible and ask yourself if the result is doable. Can you handle the maximum increase possible?

By doing this homework you’ll destroy the “unknown” beast that petrifies most homeowners who refinance or purchase a home.

Most ARM plans allow you to refinance and switch over to a fixed rate during some part of the loan period. If interest rates drop to an all time low, you can always covert to a fixed rate loan for long term security.