Now's good time to lock in a rate on some ARMs

As home prices started to soar about five years ago, many buyers took advantage of low-rate ARMs just to get a foot in the door. At the same time, mortgage rates were flirting with historic lows, and lenders began offering more interest-only loans and option ARMs, which allow borrowers to make low minimum payments. While many borrowers said they'd take the lower interest rate and put the money aside to offset higher payments later, most didn't.

If you have an ARM and you're nervous about what to do next, you're in good company. Jim McMillan, a loan officer with JP Mortgage/JPMorgan Chase, says that "What should I do with my ARM?" is the most common question he gets these days.

The answer: Start by pulling out the contract you got at settlement. To calculate the rate on your loan when it adjusts, you need to know the index your ARM is based on, the current rate on the index and the margin that's added to get your full rate. The only information your contract won't contain is the latest index rate, but you can get it for the most popular ARM indexes from HSH Associates, Financial Publishers (www.hsh.com). One bright spot: Most ARMs have an annual cap, often two percentage points.

When you have the skinny on your loan plus your latest balance, you can estimate your new payments (see the "How much will my mortgage payments be?" calculator at kiplinger.com/links/homepayments).

If you're planning to sell soon after your adjustment, refinancing may not be worth the cost and headaches. But if you're planning to stay in your home long enough to recoup your closing costs, you'd be wise to lock in a fixed rate now.

Fixed rates are still fairly low — recently 6.3 percent on 30-year mortgages — and they should remain below 6.5 percent for the rest of the year. "If you can handle the kicker of a higher monthly payment, you can get a loan you'll never have to worry about again," says Keith Gumbinger, of HSH Associates.

Expect to pay 2 percent to 4 percent of the loan amount in closing costs, or $4,000 to $8,000 on a $200,000 loan. The calculators at Mortgage Professor (www.mtgprofessor.com) can help you determine whether refinancing your ARM with a fixed-rate loan makes sense.

Some borrowers who bought at the peak of the market with interest-only and option ARMs — who have little, if any, equity in their homes — could have trouble qualifying for the higher payments of a fixed-rate mortgage. Another roadblock to refinancing is prepayment penalties, which could force borrowers to come up with thousands of dollars if they refinance within the first few years of their loan.