Do you have an adjustable rate mortgage? The clock is ticking, here’s what you need to do now

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

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

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

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

Understand your ARM terms

First, it’s essential to start with a solid understanding of the specific terms of your ARM to make the wisest financial decision.

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

Exploratory refinancing

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

For example, if your rate is set to increase but remains below current market rates, a refi may not be beneficial. Conversely, finding a slightly lower rate can provide significant relief if rates are rising beyond the manageable.

Ask about loan modifications

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

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

Use discount points

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

“Each point, which costs 1% of your loan amount, typically lowers your interest rate by less than 1%,” notes Anthony. “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 money

For those with stock investments or non-retirement accounts, consider liquidating some of these assets to make a substantial payment toward your mortgage principal. This tactic can be especially effective if you plan to refinance.

“Although the new mortgage rate may be higher than the adjusted ARM rate, the significant reduction in principal can lower or maintain the current monthly payment, making it more manageable,” explains Ralph McLaughlin, economist high on Realtor.com®.

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

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

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

Explore home equity and downsizing

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

This approach can provide a significant cash flow, providing an opportunity to downsize to a more affordable living situation, thereby reducing overall monthly expenses. This strategy is especially important in markets where property values ​​have increased significantly.

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

“It’s not about a lower quality of life, it’s about adjusting to a mortgage you can easily afford,” he continued. “If your payments go up—say by $500 or $600 a month—and your income hasn’t, using your equity wisely can be essential to keeping your financial situation manageable.”