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Pros and Cons of Refinancing an ARM to a Fixed-Rate Mortgage

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Should you go with an adjustable-rate mortgage, or ARM, for a lower initial interest rate or a fixed-rate mortgage for long-term security? That’s a question many ponder when buying a home. But for those who already have an ARM that may be adjusting soon, rising rates may trigger the need to explore a fixed-rate refinance option.ARMs are different from fixed-rate mortgages in that they offer a low initial, or “teaser,” interest rate for a period of time — typically three, five, seven or 10 years — that then adjusts to the current rate. Rates for ARMs are typically lower than fixed-rate loans, making them attractive to a range of borrowers, such as first-time buyers who need a lower rate to be able to purchase; borrowers who intend to live in their home for only a few years and to sell before their rate adjusts; and those who may be able to safely predict future salary increases to cover what likely amounts to a higher rate later on.

Mortgage rates are expected to rise throughout the next year, and that uncertainty may bring a desire for a little control. Freddie Mac has forecast 30-year fixed loans to climb above 5% in 2019 — a figure we haven’t seen since 2011 — and the Federal Reserve’s announcement that benchmark interest rates will go up again this year has those homeowners whose ARMs are adjusting soon taking note.

Advantages of refinancing from an ARM to a fixed-rate mortgage

A fixed-rate loan offers several benefits to borrowers and may be especially prudent for those who are looking for a more conservative option than their ARM.

Reduce interest rate risk. Yes, ARMs offer a low initial rate, but once they adjust, borrowers can be in for an unpleasant surprise. In fact, Fannie Mae has a specific policy designed to protect buyers from what it calls “payment shock — the impact on the borrower’s ability to continue making the mortgage payments once the introductory rate expires” by qualifying buyers not just on their payment during the introductory rate, but on an amount that better predicts the post-adjustment payment.

Allows you to create a stable budget. One of the advantages of knowing what your mortgage payment is going to be every month is that it allows you to create a long-term budget and financial plan. Budgeting is difficult enough if you don’t know your firm costs, and only estimating what your most significant expense will be can keep you from creating a stable budget and setting goals. Having a solid budget also allows you to be better prepared for surprises and emergencies.

“An ARM is adjustable, which means the rate can go up,” said Tendayi Kapfidze, chief economist at LendingTree, which owns MagnifyMoney. “With a fixed-rate mortgage, you know what the rate is going to be. You know what your payment is going to be. It’s not going to change.”

People who are planners also may have interest-rate anxiety if their rate is adjustable. All the “what ifs” related to potential future rate increases can be hard to endure. If your adjustment period is still far away and you’re already starting to panic, it may be a good time to review your options.

Potentially lower your interest rate

While there is the possibility that your interest rate will rise initially when you transition from an ARM to a fixed-rate loan, the advantage is in escaping the possibility of significant financial harm down the line. For many people, the jump from their current rate to the adjusted rate would be enough to hamper their finances. Not only is a fixed rate less risky, but it can also offer long-term savings by avoiding adjustments.

Of course, rates on ARMs can’t increase boundlessly; limits are in place that govern both annual increases and those over the life of the loan. For instance, on Federal Housing Administration one- and three-year ARMs, the rates can go up by 1 percentage point each year after the expiration of the initial rate period, and no more than 5 over the entire loan. But, even a 1-point increase can be enough to create affordability issues for those who are already financially stretched.

Downsides to refinancing your ARM

While there are many advantages to refinancing out of an ARM, doing so is not for everyone. If you tend to be more aggressive financially or are willing to take a gamble on rates staying stable, you may want to ride out your ARM until the last possible moment — and may even want to look into refinancing to another ARM at that point (more on that later).

For those who opt not to refinance at all, that decision is often due to a few potential drawbacks.

Upfront costs. As with almost any refinance, consider the fees involved because they can lower the cost benefit. You can expect to pay between 2% to 6% of the total amount you’re borrowing in closing costs. This covers things like application and origination fees, title insurance and inspection fees. You will most likely also need to pay for an appraisal, so the lender can determine the exact value of your home today. Total costs will vary, depending on where you live, and also can be different lender to lender, which might help you choose one over the other.

Interest-rate changes could be negligible. There are widespread predictions about interest rates rising in 2019, but, for now, they’re just predictions. “Some people play a game of predicting where they think rates are going to go, but I wouldn’t advise that,” Kapfidze said. “People on Wall Street are doing that every day. It’s about your personal risk profile and how comfortable you feel with interest-rate risk.”

A higher monthly payment. Borrowers who choose adjustable-rate loans often do so for the lower interest rate and lower payment, so the idea of a higher payment after switching to a fixed-rate mortgage won’t thrill them. But is the peace of mind of a fixed payment worth the higher amount? “Initially, the payment on a fixed loan may be higher than on an ARM, but, again, you’re eliminating the risk of your payment changing going forward,” Kapfidze said.

Breaking even. If you’re several years into paying your mortgage, you may not relish the idea of going backward. You can calculate your break-even time — the amount of time it will take to recover from the cost of refinancing — to help you decide whether this type of refinancing is a smart decision.

Refinancing to another adjustable-rate mortgage

The reasons you opted to go with an ARM — greater purchasing power with a lower rate, not planning to stay in the house long — might still be in play. In that case, it may make sense to refinance your soon-to-adjust loan to another ARM.

The most recent data from Freddie Mac shows 30-year fixed mortgage rates at 4.45% and a 5/1 ARM at 3.83%. An ARM could save you a considerable amount of money, but in a few years, you may find yourself in the same position again, looking to refinance into a more stable loan with fixed payment for a longer term. And there’s no telling what could happen to rates in the meantime.

Conclusion

Take your chances, or take control of your finances and your future in an uncertain time? For many, that’s the question posed by their adjustable mortgage. With a number of options for refinancing, from an ARM to a fixed-rate loan or to another ARM, buyers have a number of factors to consider, not the least of which is whether they want to refinance at all.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Jaymi Naciri
Jaymi Naciri |

Jaymi Naciri is a writer at MagnifyMoney. You can email Jaymi here

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How Credit Report Disputes Can Sabotage Your Chance for a Mortgage

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Mortgage underwriting can feel like it’s taking a lifetime when it’s standing between you and your dream home. But your lender wants to make sure that you’ll be able to repay the loan, so they’ll take the time to go over your credit history with a proverbial magnifying glass.

Before you get to underwriting, you’ll want to make sure you’re a creditworthy borrower. This means maintaining a good payment history, paying down debt and disputing any errors on your credit report.

However, credit report disputes can impact your ability to get a mortgage if they’re still pending when you’re applying for a loan. This guide will explain how and why.

Why your credit reports and scores matter

One of the first things lenders look at is your credit report, which provides information about your credit history. It details whether you’ve made on-time payments on credit cards, loans and other accounts.

The information included in this report is summed up by a credit score that generally ranges between 300 and 850. The higher your score, the more creditworthy you are perceived to be.

Although credit scores aren’t the only factor that determines whether you’ll qualify for a mortgage, your credit score heavily influences the mortgage interest rate you receive. The highest scores qualify borrowers for the best mortgage rates.

Before you begin the homebuying process, it’s smart to review your credit report and have a copy handy. You can request a free credit report once a year from each of the three major credit reporting bureaus, Equifax, Experian and TransUnion, at AnnualCreditReport.com.

It’s critical to arm yourself with this information in advance. That gives you the opportunity to dispute any inaccuracies you’ve discovered and clean up your report.

What is a credit report dispute?

Credit report inaccuracies are relatively common. Inaccurate information can happen for a variety of reasons — a credit card payment being applied to the wrong account or duplicate accounts in your report giving the impression that you carry more debt than you actually do, for example.

Not only can errors harm your credit score, but they can prevent you from qualifying for a new credit account, such as an auto or home loan. That’s why it’s important to regularly keep track of the information found in your credit reports.

When you review your credit report and find an error, you have the opportunity to formally dispute it under the Fair Credit Reporting Act This is the first step to take to get the error corrected or removed.

Fortunately, it’s easier than ever to file a credit dispute with all three credit reporting agencies online.

How to file a credit report dispute

If you’ve found an error on your credit report, take the following steps to dispute it:

  1. Provide your contact information.
  2. Identify the items in your credit report that are inaccurate.
  3. Explain why you’re disputing the info and include documentation to support your dispute.
  4. Request a correction or deletion.

You’ll also want to reach out to the creditor that is reporting inaccurate information to the credit bureaus. Let them know you’re disputing the information and provide them the same documentation you’re giving to the bureaus.

In many cases, the credit bureaus investigate disputes within 30 days, according to myFICO.com.

However, many disputes can go unresolved for long periods of time, which can be troublesome for consumers applying for a mortgage. Many loan applicants don’t realize an open credit report dispute can raise a red flag to lenders and may even prevent mortgage approval.

When to file a credit report dispute

You’ll want to file a dispute as soon as you spot an error on any of your credit reports, but if you’re thinking about buying a home in the near future, it’s best to exercise caution when filing disputes, especially right before you apply for a mortgage.

Although the dispute investigation can wrap up in 30 days, it could last as long as 90 days, so it’s best to avoid filing new disputes a few months prior to starting the homebuying process.

How mortgage lenders view credit disputes

When a dispute is filed, credit reporting agencies are required to label the item as “in dispute.” The dispute itself doesn’t impact your FICO Score. However, your score may temporarily deflate or inflate while the disputed items are being investigated.

Mortgage lenders know credit reports with disputed items don’t paint the most accurate picture of a consumer’s creditworthiness and many require this status be removed before approving a mortgage application. This leaves some consumers with a difficult decision to make — accept costly credit report errors or delay applying for a loan until disputes have been resolved.

Here’s how lenders who provide conventional and FHA loans consider credit report disputes when determining whether a consumer qualifies for a mortgage.

Conventional loans

Both government-sponsored enterprises, Fannie Mae and Freddie Mac, have automated underwriting systems that alert lenders to existing credit report disputes. These entities don’t issue loans, but buy mortgages from lenders that follow their rules.

Fannie Mae’s system initially reviews all accounts on a borrower’s credit report, even those that are being disputed. If the borrower would be approved for the loan even with the account in question, the loan moves forward. But if the disputed account would push the borrower into the “rejection” category, the system will direct the lender to investigate whether the dispute is valid.

Lenders using Freddie Mac’s system are required to confirm the accuracy of disputed accounts. The borrower would need to have the accounts corrected before the loan can move forward.

FHA loans

FHA-approved lenders require borrowers with disputed delinquent accounts on their credit report to provide an explanation and supporting documentation about their dispute. If the account has an outstanding balance of more than $1,000, the loan must be manually underwritten, which means the loan officer has to review the loan application and supporting documents outside of the automated system.

The loan officer goes over the paperwork included in the borrower’s file very closely to determine their risk of mortgage default and whether they qualify for the loan program that they’re applying.

Disputed medical accounts are excluded from consideration, but disputed accounts that are paid on time must be factored into the borrower’s debt-to-income ratio.

How to remove a lingering credit report dispute

Gaining access to a new credit report with updated information is not an option for the borrower if the creditor won’t correct the information. And when a consumer files a complaint with the credit reporting agencies, the agencies will often defer to the creditor.

Just as you’ve reached out to your creditor and the credit reporting bureaus to file your dispute, you’ll want to take the same action to remove it. Contact the creditor directly and request that they update the account information to show that it’s no longer being disputed.

You may also want to reach out to Equifax, Experian and TransUnion to request dispute removal, but keep in mind they may also reach out to the creditor who is reporting the disputed account. See the FICO website for more information about contacting each bureau’s dispute department.

The bottom line

Dealing with an unresolved credit report dispute can turn into a consumer nightmare. Even if you’ve followed best practices, you may still be unhappy with the results.

Fortunately, you can still submit a complaint to the Consumer Financial Protection Bureau. They will forward your complaint directly to the company in dispute and work to get a response from them. Another option is to seek guidance from a consumer advocate or an attorney. The National Foundation for Credit Counseling may be a helpful place to start.

Credit reports and scores have such a strong influence on lifelong financial health, so the most effective defense is to be proactive about making sure yours are in the best shape possible. Regularly monitoring your credit profile and working to fix inaccuracies before applying for a mortgage is a good game plan to prevent major problems as you embark on the homebuying process.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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