How to convert your ARM to a fixed rate mortgage

Many people who apply for mortgages get adjustable rate mortgages. These are often more affordable mortgages upfront because they offer low introductory rates, and a fixed term where your payment is low. This makes it possible for people to afford larger mortgages than they would typically be able to afford. However, as the name suggests, an adjustable rate mortgage adjusts during the course of a loan, which can mean the payment amount can go up or down.

What makes the rate adjust? The interest rate is linked to an economic index and the interest rates adjust according to the change in the index. Lenders use the index to measure interest rate changes. In addition to the index, your lender will add a markup called a margin. This is the profit the lender makes. So, for a mortgage that is an ARM, you will be charged the index rate plus the margin to get your total interest rate owed on the loan.

When index rates are low, your monthly payments are low, but when they rise, it can make the mortgage very unaffordable. So, why do people opt for this mortgage type? Well, usually when you have an ARM, you are offered what is called an adjustment period. This is a period that is either one year, three years, or five years. During the adjustment period, the interest rate will remain the same, and is typically lower then a borrower can get with a fixed rate. However, the rate will adjust once the period is over. Borrowers that have adjustable rates during times when interest rates are low usually luck out because they may pay a lower rate from what they initially signed on their loan agreement. However, for most people, having an ARM means trouble. This is because they get used to a low payment amount, and when the period ends, they may end up paying a very high monthly payment amount.

For someone looking to only own a home for a few years, an ARM could be a good way to pay less during the time you own the home. However, if your circumstances change, or if you decide to hang on to the house, it can become a very expensive mortgage type. So, what can you do? Well, if you have an ARM, and the rates are up making your payment high, it is wise to convert your ARM to a fixed rate mortgage. This will usually be a big advantage.

A fixed rate mortgage means that you are assigned an interest rate, and your rate does not change at all during the loan. This means you have a predictable, and unchanging mortgage payment amount. It also means that if you get lucky and lock in at a low rate period, that your mortgage payment each month is smaller.

There are a lot of advantages to converting your ARM to a fixed rate mortgage, but how do you go about doing so?

Getting a fixed rate mortgage is not that difficult since fixed rate mortgages have been around for a long time in the United States and are considered the most "classic" form of home loans. However, the type of fixed rate mortgage you get may vary. Fixed rate mortgages are either 15-years, 20-years, or 30-years although some have been approved for 40 or 50 years, though this very rare.

Here are the steps for converting an ARM to a fixed rate mortgage:

First, you have to decide when you want to convert. If you have an ARM and you are finding that the monthly payment amount is getting to be too large, and you are having trouble making your obligation, it may not be a good time to convert because this means rates are high, so you might be wanting to convert at a time when you will pay more over time. However, it might be one of your only options for not going into foreclosure. So, if you can help it, plan ahead. You want to decide how long you intend to own the home. If you plan on staying longer than 5 years, you should switch to a fixed rate loan before the ARM adjustment period ends, as this will help you save money. However, if you can help it, look to switch it when rates are low.

Second, if you want to convert your ARM to a fixed rate mortgage then contact your lender right away. It takes some time to get all of the necessary paperwork, get the loan through underwriting, and close on a new loan, and since the mortgage rates can change in the blink of an eye, the faster you do this, the more likely you are going to be to get the loan converted and locked into the rate that you want. So the thing you need to do after deciding to convert is to let your lender know.

Next, you will need to answer their questions and provide them with the proper documentation. Your lender is going to want to know why you want out of your current mortgage, and into a different one. You need to give them a good enough reason so that they do not put the time and effort in to convert your loan type and then have you change your mind. So, you need to show them your income, your debts, and your other financial obligations. They will be able to determine from these things that you would benefit from fixing a rate. Most lenders will ask you to provide them with current paystubs, bank statements, and a current credit report so they can calculate a debt to income ratio. If you carry too much debt, it may not be possible to convert your loan. Your lender will evaluate whether or not your finances qualify for you to get a new loan type. Sometimes during a recession finances change, you may lose a job, or take a pay cut. If this happens you may not be eligible for a new loan. So, if you are at all worried about employment changes, it is smart to try and convert your loan before that happens. However, in some cases a lender will allow you to convert your loan because your situation changes and it is convert the loan or lose the home. Of course if this is your situation you will need to contact your lender immediately and they will discuss your options with you.

Next, evaluate your finances. Remember, in many cases it is going to cost you money to refinance your loan and convert it into a fixed rate mortgage. So, you need to be sure to evaluate your finances to ensure that this is going to be worth it to you. If it costs you $2500 to convert your loan, and it saves you $200 a month, it will take 13 months before you are getting any advantage. So, if you plan to move or sell before that time, it does not make sense to convert. However, because rates change you can't be positive what your monthly savings will be, but it is still wise to evaluate. Let's say you decide to convert, and you just wrap the closing costs into the loan amount making it so you owe more. Your monthly payment then drops some, and let's say you lose your job. At this point, converting your mortgage was a wise decision because although you owe a little more, your monthly obligations are lower, making it easier to make ends meet until you find another job. However, in other situations, it may not be as favorable. For example, let's say you refinance and wrap the same amount of closing costs into the loan, raising the total amount owed. Then let's say a few months later you get transferred for your job and have to sell. You end up losing money. So, look at your situation, look at what will benefit you more, more now or more later, less now, or less later? The answer to that question should play a big part in determining if and how you convert your ARM. In addition, you want to evaluate the state of your credit. Sometimes people start out with an ARM because they did not have the credit score to get them a favorable rate for a fixed mortgage initially. If your credit has improved, then converting to a fixed mortgage may be really wise because you may qualify for really great rates.

Next, you want to make sure your lender locks in an interest rate when rates are low. So, if the economy is in recession, as it is now, it could be tempting to stay in an adjustable rate mortgage as your payment may continue going down. However, when the recession ends, you will have to pay the rising rates. So, it is better to lock in while it is low. This gives you the peace of mind of knowing for the remainder of the loan you will be paying a lower amount, and it will also mean that you know exactly what your monthly obligation will be. This can be nice for helping you plan your emergency fund, and in helping you determine how financially secure you will be during a recession.

Last, but not least, when you convert your ARM to a fixed rate mortgage, make sure that you review all the terms of the new loan before signing anything. Sometimes there are hidden fees, balloon payments, or other things that are not beneficial to you, such as prepayment penalties. It does not matter how much time or effort the lender has put into your loan, if there are things in the closing paperwork you did not agree to, do not sign it until they change the paperwork to what you agreed on.