Today’s high interest rates have created a ticking time bomb for the many homebuyers who took out an adjustable-rate mortgage near the onset of the COVID-19 pandemic.

About 330,000 homeowners who got an ARM in 2019 have already seen their five-year fixed-rate term end, and 100,000 more will join them in the next year, according to ICE Mortgage Technology.

With mortgage rates currently at 20-year highs, many homebuyers could face rate adjustments upward that could cause their monthly mortgage payments to balloon or even double.

Facing an adjustment on an ARM can be daunting, but homeowners can navigate these changes in various ways. Here’s how to handle an adjustment without capsizing your financial boat.

Understand your ARM terms

First, it’s crucial to start with a solid understanding of the specific terms of your ARM to make the most financially savvy decision.

“Homeowners should be acutely aware of when their rate will adjust, the new potential rate, and any caps that limit rate increases,” says William Anthony, a mortgage loan originator with Ace Land Mortgage. “This understanding is essential to planning for the future and exploring viable options. Familiarizing yourself with these details allows for better strategic planning and could prevent costly surprises.”

About 330,000 homeowners who got an ARM in 2019 have already seen their five-year fixed-rate term end. Bussakon – stock.adobe.com

Explore refinancing

Refinancing might seem like a knee-jerk reaction. However, the process and decision to refinance will depend heavily on the borrower’s current rate versus what they would be refinancing into.

For instance, if your rate is set to increase but remains below current market rates, a refi might not be beneficial. Conversely, finding a slightly lower rate could provide significant relief if rates are climbing beyond manageable.

Ask about loan modifications

For homeowners struggling to meet their newly adjusted mortgage obligations, a loan modification might be the right solution. Modifications can adjust the terms or length of your mortgage, such as extending a 30-year loan to a 40-year term, which lowers the monthly payments by spreading them out over a longer period.

“This can reduce both principal and interest payments significantly, easing the monthly financial pressure,” Anthony adds.

If your rate is set to increase but remains below current market rates, a refi might not be beneficial. Andrii Yalanskyi – stock.adobe.com

Use discount points

Another refinancing strategy involves purchasing discount points. This option allows homeowners to pay an upfront fee to reduce their mortgage interest rate.

“Each point, which costs 1% of your loan amount, typically lowers your interest rate by less than 1%,” Anthony notes. “This can be a wise investment if you plan to stay in your home long term, as it reduces monthly payments and overall interest paid over the life of the loan.”

Use extra cash

For those with investments in stocks or nonretirement accounts, consider liquidating some of these assets to make a significant payment toward your mortgage principal. This tactic can be particularly effective if you’re planning to refinance.

“Although the new mortgage rate might be higher than the adjusted ARM rate, the substantial reduction in principal could lower or maintain the current monthly payment, making it more manageable,” explains Ralph McLaughlin, senior economist at Realtor.com®.

And let’s not forget that maybe you can make the higher monthly mortgage payments if you free up cash elsewhere.

McLaughlin advises ARM borrowers to “try to reduce their total monthly outlays by using extra cash on hand to pay off things like credit cards, auto loans, or student debt that would amount to a net zero change in total monthly payments.”

This strategy optimizes your financial obligations to ensure more of your income is available to handle increased mortgage payments.

“Each point, which costs 1% of your loan amount, typically lowers your interest rate by less than 1%,” Anthony notes. wutzkoh – stock.adobe.com

Explore home equity and downsizing

Finally, if the adjusted payments become unmanageable and other strategies prove insufficient, selling your home to capitalize on accrued equity is another option.

This approach can provide a substantial financial influx, offering an opportunity to downsize to a more affordable living situation, thereby reducing overall monthly expenses. This strategy is especially pertinent in markets where property values have increased significantly.

“If your home has appreciated and selling it could yield a profit, then downsizing might be the best option,” says Anthony.

“This isn’t about a lower quality of living, but adjusting to a mortgage that you can comfortably afford,” he continues. “If your payments spike—say by $500 or $600 a month—and your income hasn’t increased, using your equity wisely could be essential to keep your financial situation manageable.”

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