Have an Adjustable Rate Mortgage?
A quarter-point (0.25%) interest rate hike by the Federal Reserve means the central bank has confidence that the economy is growing strong enough to handle higher borrowing costs. It is generally a positive signal that jobs are secure and consumer spending is resilient. For the broader real estate market, a minor hike is easily absorbed and rarely causes a crash.
If you are holding an Adjustable-Rate Mortgage (ARM), a rising rate environment introduces the risk of "payment shock." To protect your capital from total volatility, you should begin by evaluating your lock period to check how much time is left on your fixed-rate introductory period. Next, stress-test your budget by calculating how a 1% to 2% total increase over the next couple of years would impact your monthly cash flow. If you plan on staying in your home long-term, it may be wise to consider refinancing into a fixed-rate mortgage before further hikes occur.
When evaluating your strategic action options, your first choice is to refinance into a Fixed-Rate Mortgage (FRM). This completely eliminates the threat of future Fed rate hikes by converting your loan into a predictable, fixed-rate mortgage. This path is best for homeowners who plan to stay in their current house for the long term (5+ years) and want guaranteed payment stability. However, be aware of the hidden costs, as you will need to pay standard refinancing closing costs that typically range from 2% to 5% of the loan amount; you must ensure you stay long enough to break even on those fees.
Alternatively, you can look into using a built-in "conversion" feature. Some ARM contracts contain a convertibility clause that lets you change your adjustable rate into a fixed rate for a small fee without undergoing a full, expensive refinancing process. This strategy is ideal for avoiding hefty closing costs while still locking down your payment. The trade-off is that the fixed rate offered through a conversion clause is often slightly higher than prevailing market refinancing rates. You should review your original loan paperwork or call your servicer to see if you have this option.
Another effective approach is to make aggressive principal prepayments. Unlike fixed loans, when an ARM reaches its adjustment date, the new payment is calculated based on your remaining principal balance. Making extra principal payments now lowers the principal baseline, directly reducing the severity of your future payment spike. This is best for borrowers who are still in their initial fixed-rate period and have extra monthly cash flow or liquid cash reserves. As a point of verification, ensure your lender does not charge any prepayment penalties, though most modern, conventional conforming ARMs do not.
Finally, you can execute an exit strategy by selling the property or refinancing into a new ARM. If you planned to move within a few years anyway, you can list the home and pay off the loan before the higher rates kick in. Alternatively, you can refinance into a new hybrid ARM to lock in another introductory fixed-rate window, such as a new 5-year or 7-year lock.
Contact John Catalano and the Heroes Real Estate Program for any questions about today's real estate market. John Catalano is the owner operator of the Heroes Program since 2007 and is a retired law enforcement officer of 24 years in Los Angeles. As a retired police officer, John and his team continues to give back to the community.
Our team members cover all of Los Angeles County with various offices located throughout.
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