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Reasons to Change Your Mortgage Program When You Refinance

Reasons to Change Your Mortgage Program When You Refinance

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience
  • The Benefits of Refinancing to Change Loan Programs
  • One potential reason to refinance your mortgage is to change loan programs.  You may have a loan program such as adjustable rate mortgage (ARM) or interest only loan that involves higher risks and potential payment shock.  For example, one of the biggest risks of an ARM is that your monthly payment increases significantly if interest rates rise.  Refinancing an ARM into a fixed rate mortgage can protect you against potential future monthly payment increases and potentially save you thousands of dollars in interest expense over the life of the loan.  It is highly challenging to predict mortgage rates but if you think rates are going to increase and you have an ARM or an interest only loan, it may make sense to refinance into a fixed rate mortgage to avoid a possible payment spike and to gain more financial certainty.

  • Great Mortgage IdeaRefinancing an ARM or interest only loan into a fixed rate mortgage provides certainty and can save you thousands of dollars in the long run 
  • Because the initial interest rate for an ARM or interest only loan is typically lower than the rate for a fixed rate mortgage, you may have a higher monthly payment for the first several months or years after you refinance, depending on how rates today compare to rates when you obtained your original mortgage.  If interest rates increase over time, however, the monthly payment on the fixed rate mortgage does not change while the payment on the ARM or interest only loan could continue to rise.  So in the short term refinancing into a fixed rate mortgage may cost you more due to closing costs and a higher monthly payment, but over time, refinancing to change your mortgage program should result in a lower monthly payment as compared to not refinancing, reduced total interest expense and the peace of mind that comes from knowing that your monthly payment is fixed.

    The rationale for refinancing to change your mortgage program works both ways.  Although less common, some borrowers may benefit from refinancing a fixed rate mortgage into an ARM or interest only loan.  For example, if you obtained your loan when interest rates were high, you may be able to refinance into a lower rate and reduce your monthly payment by switching from a fixed rate mortgage to an ARM or interest only loan.

  • CalculatorUse our MORTGAGE REFINANCE CALCULATORto determine if you should refinance
  • These mortgage programs may also enable you to qualify for a higher loan amount which may be another reason to switch programs when you refinance, especially if you are looking to take cash out of your home. Additionally, if you believe mortgage rates are going to decline, then an ARM or interest only mortgage may enable you to benefit from a lower monthly payment in the future as compared to a fixed rate loan with a payment that never changes.  Forecasting interest rates is highly challenging so borrowers should exercise caution with this approach. The last thing you want is to refinance into an ARM or interest only loan and then not be able to afford your mortgage and monthly payment in the future.

    The table below compares interest rates, APRs and closing costs for fixed rate mortgages.  We recommend that you contact multiple lenders in the table to request refinance proposals.  Comparing lenders and loan programs enables you to find the best refinance terms including the lowest rate and fees.

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    Current Refinance Mortgage Rates as of January 23, 2019
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click here for more information on rates and product details.
  • Example: Refinance to Change Mortgage Progams
  • The example below demonstrates the benefits of refinancing an adjustable rate mortgage into a fixed rate loan in an increasing interest rate environment.  The benefits include a lower mortgage rate and monthly payment over the majority of the new fixed rate mortgage as well as reduced total interest expense.  In the example, the original mortgage is a 7/1 ARM that the borrower refinances at the end of year five.  The mortgage rate on the original loan is fixed for the first seven years and then is subject to adjust on an annual basis in years eight through 30 of the mortgage, which exposes the borrower to significant risk if interest rates go up.  Full details of the original 7/1 ARM and new fixed rate mortgage are below:

  • Key Assumptions

    Original Mortgage – Adjustable Rate Mortgage (ARM)

    Mortgage amount $380,000 Index 1 Year LIBOR (.860%)
    Mortgage term 30 years Margin 2.250%
    Fixed rate period Seven years Initial adjustment cap 5.000%
    Fixed period interest rate 2.750% Subsequent adjustment cap 2.00%
    Adjustment Period Annual Life cap 5.00%

    Refinanced Mortgage – Fixed Rate Mortgage

    Mortgage amount $380,000 Interest rate 5%
    Mortgage term 30 years
  • For the purpose of this example, we show the fastest possible increase in the mortgage rate for the ARM during the loan's adjustable rate period until the rate reaches its life cap in year eight and remains at that level until the end of the loan.  While this is a pretty drastic example, it effectively shows the possible risks an ARM as well as the reasons to refinance into a fixed rate mortgage.  We compare this scenario to a case when the borrower refinances the ARM at the end of the fifth year into a 30 year fixed rate loan with an interest rate of 5.000%.  The principal amount of the mortgage does not change when the loan is refinanced.

    The chart below compares the monthly payment and total interest expense for the original 7/1 ARM with the new 30 year fixed rate mortgage.  In short, the chart enables you to review the outcome if the borrower did not refinance.  Initially, refinancing is more expensive for the borrower -- in years six and seven the interest rate and monthly payment for the fixed rate mortgage are higher than for the ARM.  However, as the mortgage rate increases when the ARM enters its adjustable rate period in year eight and beyond, the fixed rate mortgage offers the borrower a lower monthly payment and significantly reduced total interest expense as compared to the original loan.

    By refinancing into a fixed rate mortgage at the end of year five, the borrower gains certainty over his or her monthly payment, reduces his or her monthly payment by $425 in years 8 through 30 of the loan and saves a total of $76,224 in interest expense over the life of the mortgage. While this example shows the most extreme scenario for the adjustable rate mortgage, it also demonstrates the significant benefits of refinancing to change mortgage programs, especially if you think rates are going to rise.

  • Monthly Mortgage Payment Comparison
    Monthly Mortgage Payment
    • Refinanced Fixed Rate Mortgage
    • Original Adjustable Rate Mortgage
    • $3,000
    • $2,500
    • $2,000
    • $1,500
    • $1,000
    • $500
    • $0
    Monthly mortgage payment for first seven years: $1,551
    Monthly mortgage payment for last
    23 years: $2,465
    Average monthly
    mortgage payment:
    Total interest expence
    over the life of the
    mortgage: $430,624
    Monthly mortgage payment for
    30 years: $2,040
    Monthly mortgage:
    Total interest expense
    over the life of mortgage: $354,400
    • Year 1
    • Year 2
    • Year 3
    • Year 4
    • Year 5
    • Year 6
    • Year 7
    • Year 8
    • Year 9
    • Year 10
    • Year 11
    • Year 12
    • Year 13
    • Year 14
    • Year 15
    • Year 16
    • Year 17
    • Year 18
    • Year 19
    • Year 20
    • Year 21
    • Year 22
    • Year 23
    • Year 24
    • Year 25
    • Year 26
    • Year 27
    • Year 28
    • Year 29
    • Year 30
    • Year 31
    • Year 32
    • Year 33
    • Year 34
    • Year 35
  • Below we present findings from the example in table format.  Using the same assumptions, the table compares the original 7/1 ARM to a refinanced 30 year fixed rate mortgage put in place at the beginning of year six.  The table illustrates the monthly mortgage payment savings that begin in year eight as well as the reduction in total interest expense realized by refinancing.  In the example, even though the borrower extends the original mortgage term five years, by refinancing and changing loan programs, the borrower lowers his or her monthly payment beginning in year eight and reduces total interest expense by almost $80,000.

  • Refinance Your Adjustable Rate Mortgage into a Fixed Rate Mortgage
    Original 7/1 ARM Refinanced 30
    Year Fixed Rate Mortgage
    Savings / (Difference)
    Mortgage Amount $380,000 $380,000
    Years 1 – 5 Interest rate 2.750% Not applicable
    Monthly Mortgage Payment $1,551 Not applicable
    Years 6 – 7 Interest rate 2.750% 5.0% (2.250%)
    Monthly Mortgage Payment $1,551 $2,040 ($489)
    Years 8 – 30 Interest rate 7.750% 5.0% 2.250%
    Monthly Mortgage Payment $2,465 $2,040 $425
    Years 31 – 35 Interest rate Not applicable 5.0%
    Monthly Mortgage Payment Not applicable $2,040
    Total Interest Paid Over the Life of Mortgage $430,624 $354,400 $76,224
  • Use our free personalized mortgage quote form to review no obligation refinance quotes. Our quote form is easy-to-use, requires minimal personal information and does not affect your credit. Comparing multiple proposals is the best way to save money when you refinance.

  • Sources

    Mortgage Refinance:

About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry


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