Can You Refinance ARM Loans? Here’s What to Know

An Adjustable-Rate Mortgage (ARM) represents a home loan where the interest rate can change periodically after an initial fixed period. This means that while payments begin with a stable rate, they may fluctuate over time based on market conditions. Borrowers often consider an ARM for its typically lower initial interest rates compared to fixed-rate options. It is possible to refinance an ARM loan, allowing homeowners to replace their current mortgage with a new one.

Eligibility for Refinancing

Qualifying for an ARM refinance involves meeting specific financial and property-related criteria. A strong credit score is a primary factor, with conventional loans typically requiring a minimum score of 620. A higher credit score can lead to more favorable interest rates on the new loan. For government-backed loans like FHA, a credit score as low as 580 might be accepted, while VA loans often look for scores around 620 to 640.

Lenders also assess a borrower’s debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. Most lenders prefer a DTI ratio below 43%. Some conforming loan programs might allow a DTI up to 50%, but a lower ratio provides more options and demonstrates financial stability. Employment history and income stability are also reviewed, requiring documentation such as pay stubs, W-2 forms from the past two years, and recent tax returns to verify consistent earnings.

The property itself must also meet certain qualifications, particularly concerning its loan-to-value (LTV) ratio and the homeowner’s equity. For a conventional refinance, lenders commonly require at least 20% equity in the home, meaning the loan amount should not exceed 80% of the home’s appraised value. This equity requirement helps protect the lender and can allow the borrower to avoid private mortgage insurance. A history of consistent, on-time payments on the existing ARM is also important, as lenders look for no late payments within the last 6 to 12 months.

Available Refinancing Loan Types

When refinancing an Adjustable-Rate Mortgage, homeowners have several options for the new loan. A common choice is to refinance into a fixed-rate mortgage, where the interest rate remains constant for the entire loan term. These loans offer predictable monthly payments and are available in various terms, such as 15-year or 30-year periods.

It is also possible to refinance an existing ARM into another Adjustable-Rate Mortgage. This might be considered if a borrower seeks a new ARM with a different initial fixed period or a more favorable index and margin structure. Common new ARM types include the 5/1 ARM and the 7/1 ARM; the first number indicates the years the rate is fixed, and the second indicates how often it adjusts thereafter.

Another refinancing option is a cash-out refinance, which allows a homeowner to convert a portion of their home equity into cash. With this type of refinance, the new mortgage is for a larger amount than the existing balance, and the difference is disbursed to the borrower as a lump sum. The funds from a cash-out refinance can be used for various purposes, such as home improvements, or debt consolidation.

Required Documentation and Information

To apply for an ARM refinance, borrowers must gather and provide documents and information to the lender. Personal identification is required, such as a government-issued photo ID, to verify identity and prevent fraud. This step ensures the application is legitimate and linked to the correct individual.

Income verification is a significant component, requiring recent pay stubs and W-2 forms from the previous two years. For self-employed individuals, lenders request profit and loss statements, business bank statements, and business tax returns for the past two to three years. These documents help the lender assess the borrower’s ability to manage new mortgage payments.

Asset verification is also necessary to demonstrate financial reserves. This involves providing bank statements, as well as statements from investment or retirement accounts. Information regarding the current mortgage is also crucial, including recent mortgage statements, the property deed, and a property survey if available. Additionally, lenders will request current homeowners insurance policies and property tax statements.

The Refinancing Process Steps

After preparing the necessary documentation, the refinancing process begins with the application submission to a chosen lender. This involves completing the application forms and providing all the collected financial and personal documents. The lender then moves into the underwriting phase, where a thorough review of the borrower’s financial data and submitted documents occurs. This stage may involve follow-up questions or requests for additional information to clarify aspects of the application.

During underwriting, the lender will order a property appraisal to determine the home’s current market value. A title search is also conducted to ensure there are no undisclosed liens or claims against the property. These steps are essential for the lender to assess the collateral for the new loan and protect their interest.

Once the underwriting is complete and all conditions are met, the loan is approved, and the borrower receives a loan offer. This offer includes details of the new mortgage, such as the interest rate, loan term, and monthly payments. The lender also provides a Closing Disclosure document, which itemizes all costs associated with the refinance. The final stage is the closing, where all parties sign the necessary legal documents. At closing, the borrower will pay closing costs, which typically range from 2% to 6% of the new loan amount, and the funds are then disbursed to pay off the old mortgage and finalize the new one.