Can You Refinance a Variable Rate Mortgage?

A variable-rate mortgage (ARM) features an interest rate that can change periodically based on an underlying index. This fluctuation means monthly payments may increase or decrease, introducing unpredictability. Homeowners with an ARM often consider refinancing. Refinancing is generally possible and can be a significant financial decision for those seeking stability or different loan terms.

When to Consider Refinancing

Homeowners with an ARM consider refinancing for various reasons. The prevailing interest rate environment plays a significant role; rising market rates or the expectation of future increases can make a fixed-rate mortgage more appealing. An ARM’s adjustment periods and interest rate caps determine how often and by how much your rate can change, influencing the urgency of such a decision.

Many homeowners seek payment stability and predictability to better manage their household budgets. Switching from a variable rate to a fixed rate provides certainty regarding monthly mortgage payments over the long term. This aligns with financial goals that prioritize consistent expenses, making it easier to plan for other financial objectives.

Refinancing also offers the opportunity to adjust the loan term. Homeowners might shorten the loan term to pay off the mortgage faster, potentially saving on total interest paid over the life of the loan. Conversely, extending the loan term can reduce monthly payments, providing more financial flexibility in the short term. Sufficient home equity and a strong credit score can lead to favorable refinancing terms.

Preparing for a Refinance Application

Successful refinancing begins with thorough preparation, including gathering necessary financial information and understanding lender requirements. Lenders assess your creditworthiness, with minimum credit scores ranging from 620 for conventional loans to 580 for FHA loan refinances. Higher scores secure better rates. Your credit history, which reflects your past borrowing and repayment behavior, is also reviewed.

Lenders verify income and employment to ensure a stable ability to repay the new loan. This requires providing pay stubs from the past 30 days and W-2 forms from the previous two years. Self-employed individuals may also need to provide personal tax returns for the last two years, year-to-date financial statements, or profit and loss statements.

The debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income. For most refinance loans, a DTI of 50% or less is preferred for conforming loans, while jumbo loans may require a DTI of 43% or less. Lenders also evaluate home equity, which determines your loan-to-value (LTV) ratio. For conventional refinance loans, an LTV of 80% or less is typical to avoid private mortgage insurance. An appraisal of your home is required to determine its current market value, which is essential for calculating the LTV.

To streamline the application process, have a comprehensive set of documents ready. These include:
Your current mortgage statement
Property tax statements
Homeowners insurance policies
Bank statements from the past two months
Personal identification, such as a driver’s license

Having these documents organized can expedite the application.

Navigating the Refinance Process

After preparing your financial documents and understanding the requirements, the next step involves navigating the formal refinance process. Begin by shopping for lenders and comparing their offers, as rates and terms vary significantly. Many lenders allow you to submit a formal application online, while others may require an in-person submission.

Once the application is submitted, the appraisal and underwriting stages commence. An appraisal determines the current market value of your property, which is then used to calculate the LTV ratio for the new loan. Underwriting involves the lender’s comprehensive evaluation of your financial risk, reviewing all provided documentation, including credit history, income, and assets.

It is common for lenders to issue a conditional approval and request additional information or clarification on certain documents. This stage ensures all details are accurate and complete before final approval. You may need to provide updated pay stubs or explanations for any unusual bank account activity.

The final step is closing, where you review and sign all loan documents. This typically occurs at a title company or attorney’s office. At closing, you will also pay closing costs, which are fees associated with processing the refinance. These costs can range from 2% to 6% of the loan amount and may include:
Origination fees
Appraisal fees
Title insurance
Recording fees

Common Refinance Options

When refinancing a variable-rate mortgage, homeowners typically choose from a few common loan options that offer different benefits. The most frequent choice is a fixed-rate mortgage, which provides a stable interest rate for the entire loan term, ensuring predictable monthly payments. Common fixed-rate terms include 15-year and 30-year options, allowing homeowners to select a repayment schedule that aligns with their financial planning.

Fixed-rate mortgages eliminate the risk of interest rate increases, a significant advantage in a rising rate environment. This predictability aids in budgeting and offers peace of mind for the duration of the loan. Many homeowners prioritize this stability over the potential, but uncertain, savings of a fluctuating rate.

Another option is a cash-out refinance, which allows homeowners to tap into their home equity while simultaneously refinancing their existing mortgage. This involves taking out a new mortgage for a larger amount than what is currently owed, with the difference paid out to the borrower in cash. While providing access to funds, this option increases the loan amount and therefore the total interest paid over time.

Refinancing also offers the flexibility to adjust the loan term to better suit financial goals. For example, a homeowner might refinance a 30-year ARM into a 15-year fixed-rate mortgage to accelerate repayment and reduce total interest costs. Alternatively, extending the loan term can lower monthly payments, providing greater cash flow for other expenses or investments.