If Your Adjustable-Rate Mortgage Is Nearing a Reset, Here Are 5 Steps to Take

Homeowners with adjustable-rate mortgages may soon face larger monthly bills as introductory rates expire. Here's how to get ready and when refinancing might make sense.

People who took out adjustable-rate mortgages, or ARMs, when interest rates were near historic lows could be in for an unwelcome change. Once the introductory period ends, some borrowers may see their monthly mortgage payment rise by hundreds of dollars or more.

Unlike fixed-rate mortgages, ARMs can change after an initial fixed-rate period. For homeowners who locked in rates around 3% during the pandemic, the first adjustment could put real pressure on household budgets.

Refinancing into a fixed-rate mortgage may look like the simplest answer, but current rates could make that move costly. The good news is that there are other ways to prepare. Here are five steps to consider before your ARM resets.

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1. Confirm when your ARM resets and estimate your new payment

If you have an ARM, start by finding out when the initial fixed-rate period ends.

For instance, a 5/1 ARM keeps the original interest rate for five years before annual adjustments begin. A 7/1 ARM preserves the initial rate for seven years. Some ARMs adjust even more frequently, such as every six months, so payment changes can vary widely depending on the loan.

Your new rate usually comes from two parts: a benchmark index such as the Secured Overnight Financing Rate, or SOFR, and a margin set by your lender. Together, they form the fully indexed rate.

Most ARMs also include caps that limit how much the rate can rise at the first adjustment, at later adjustments, and over the life of the loan. Review your loan documents or contact your mortgage servicer to confirm the reset date, index, margin and rate caps.

In most standard cases, your servicer must send an initial adjustment notice well before the first higher payment is due. Still, it is smart to begin planning long before that notice arrives.

2. Compare the cost of refinancing before you switch to a fixed-rate loan

The main danger with an ARM is that a higher rate could push your mortgage payment beyond what you can comfortably afford. Refinancing can help stabilize the payment, but it does not always save money.

If your ARM started with a low introductory rate, refinancing before the reset could actually raise your monthly bill. Even after the rate adjusts, keeping your current loan may be cheaper than replacing it with a new fixed-rate mortgage.

For example, suppose you still owe $300,000 and have 25 years left on the loan. If your ARM rate rises from 3% to 5%, and the average 30-year fixed-rate mortgage is 7.32%, the monthly principal-and-interest payments would look like this:

In that example, keeping the ARM would be about $307 cheaper per month, or $3,684 less per year, than refinancing into a 30-year fixed loan. But the ARM could reset again later, which could push the payment even higher.

Refinancing may make more sense if you plan to stay put for many years, want a predictable payment or expect your ARM rate to climb substantially.

Before deciding, compare quotes from multiple lenders and account for closing costs, which often total about 2% to 5% of the loan amount. Also think about whether restarting a 30-year term would increase your total interest expense.

Refinancing is not always the cheapest route, but reviewing current mortgage offers can help you judge whether it is worth pursuing.

Use the tool below to explore current refinance offers:

3. Think about extra principal payments before the rate changes

Paying down your mortgage balance before the reset may reduce the impact of a higher rate. When the loan adjusts, the new principal-and-interest payment is typically calculated using your remaining balance, the new interest rate and the time left on the loan.

Extra principal payments can reduce the interest you owe and may also lower the amount you pay once the ARM adjusts. However, making extra payments does not always reduce the required monthly payment right away.

Another possibility is a mortgage recast, which lets eligible borrowers make a lump-sum principal payment and have the lender recalculate the monthly payment based on the smaller balance. Not every loan qualifies, and availability for ARMs depends on the lender and loan type.

Before sending extra money, ask your mortgage servicer how paying down the balance would affect the next adjustment and whether recasting is an option.

Keep your emergency savings in mind as well. Putting thousands of dollars toward the mortgage may save on interest, but it also leaves less cash on hand for unexpected costs.

4. Contact your mortgage servicer before you fall behind

If the new payment could be hard to afford, reach out to your loan servicer as soon as possible. Depending on the loan, your financial situation and your eligibility, the servicer may offer help such as a loan modification or another mortgage relief option.

A loan modification changes certain terms of the existing mortgage and may make payments more manageable. Approval is not guaranteed, and some relief programs require proof of hardship, but it is still worth checking.

You can also consult a HUD-approved housing counselor for free or low-cost help reviewing your options and managing the mortgage.

If the higher payment would create a long-term strain, selling the home or downsizing may be worth considering, especially if you have built substantial equity. That said, selling is not the right answer for everyone, particularly once moving costs and the expense of buying another home are included.

Even so, exploring options before you fall behind could help you avoid worse financial problems later.

5. Get your budget ready for a higher housing payment

Anyone with an ARM likely knew the rate would eventually rise. One of the simplest ways to handle that change is to prepare ahead of time so it does not hit your finances all at once.

Start by estimating how much more you will owe each month. If your payment is expected to rise by $400, that adds up to $4,800 a year.

Look over your current spending and find places where you can free up cash. That might mean cutting discretionary purchases, canceling unused subscriptions or temporarily slowing other savings goals.

You can also build a reserve specifically for the higher payment during the first few months after the reset. For example, setting aside $400 a month for six months would create a $2,400 cushion. It also gives you a chance to see whether your budget can truly handle the new amount.

Remember that your mortgage is not the only housing expense that may rise. Property taxes, homeowners insurance, HOA dues and maintenance costs can also affect your total housing budget.

If you are nearing retirement or living on a fixed income, planning for those costs is especially important. A higher mortgage payment could leave less room for healthcare, travel or other priorities.

Do not wait until the reset to make a plan

An ARM reset does not automatically mean financial trouble, but it can become an expensive surprise if you are unprepared.

Before refinancing, review your loan terms and compare the adjusted payment with the cost of a new mortgage. Paying down principal, looking into assistance programs and creating extra room in your budget can also help.

The sooner you start planning, the more choices you will have to handle a higher payment without derailing your other financial goals.

If you are unsure how a larger mortgage bill could affect your long-term finances, a financial adviser can help you weigh the options and build a plan.