Homeowners on the move to Refi City

NEW YORK (CNNMoney.com) -- Rarely has there been such an advantageous time to refinance into a 30-year fixed-rate mortgage if you have an adjustable-rate loan. But homeowners' love affair with riskier ARMs is still strong.

The average rate on the 30-year loan has fallen more than three-quarters of a percentage point since July, and it is near its lowest level since October 2005. Rates on ARMs, meanwhile, haven't fallen nearly as far.

According to financial information publisher HSH Associates, a one-year ARM, at 5.8 percent on average, now costs only a third of a percentage point less than a 30-year fixed-rate mortgage, at 6.2 percent. And ARM holders still face the risk of paying a higher interest rate down the road.

But while there's a new refi boom in swing, not all borrowers are rushing for the security of fixed loans. One in three homeowners refinancing today is choosing the financially riskier interest-only and payment-option ARMs, according to data from Loan Performance.

Many who are doing so may have chosen those mortgages not because they want them but because they can't afford the payments that would come due under a 30-year fixed rate, said Keith Gumbinger, HSH's vice president. Some may be speculators who want to flip their property when prices improve and want to keep their costs as low as possible in the meantime.

Interest-only and payment-option loans typically offer lower monthly payments than fixed-rate or traditional adjustable-rate mortgages - at least for a short period. But they also carry with them the risk of greater payment shock when the loan readjusts upward and greater risk of owing more on your home than you could sell it for, especially if home prices fall.

With an interest-only ARM, you only pay interest due on the loan, and you don't pay down any principal for a period of time - typically one to five years - after which the loan rate resets to an adjustable rate tied to the prime (currently 8.25 percent) or to a predetermined fixed rate, depending on the loan's terms.

With a payment-option ARM, which often comes with an initial teaser payment rate of 2 percent or less, you can choose from one of four payment options every month depending on your cash-flow needs. You could make a 30- or 15-year fixed payment or just pay the interest. Or you could pay even less with the minimum-payment option.

With this fourth option, not only are you failing to build equity; you're not even paying off the interest you owe, which increases your loan balance - a condition known as negative amortization. Negative amortization can leave a homeowner in a bad spot if home prices fall or stay flat, or if the homeowner experiences a financial emergency.

If you have an ARM where your monthly payments are about to ratchet up steeply or you are dangerously close to having a negatively amortized loan, the low rates on the 30-year fixed-rate loans this month (which defied forecasts) offer you a window of opportunity to lock in a low rate long term.

There may be some payment shock if you've been in an ARM, "but it will be less than if you wait," said Bob Visini, Loan Performance's vice president of marketing.

Here are five cost-effective steps that Wachovia mortgage banking executive Blair Glenn and George Hanzimanolis, president-elect of the National Association of Mortgage Brokers, recommend if you refinance:

• Ask your original lender if you may modify (or recharacterize) your loan into a fixed-rate mortgage. With fees that range from $250 to $500, this process is less costly and less intensive than a full refinancing - which typically runs between 0.5 percent to 2 percent of the loan amount. But a modification may prove more expensive long term if the fixed rate your lender offers is more than three-quarters of a point above the going rate you'd get on a regular refi. So make sure you shop around for the best rates and closing costs, then do an apples-to-apples comparison.
• Consider whether it makes sense to buy points. Points are money you pay up-front to lower the fixed rate on your mortgage. If you think rates will fall and you'll refi again soon, it may not make sense to buy points. But if you think rates are as low as they're going to get for awhile, it might save you a lot of money long term to lower your rate today.
• Ask to pay the "reissue" rate on your title insurance in a refi. It costs about 20 percent less than the standard title rate on new mortgages.
• Opt for a full appraisal, even if your lender only requires a "drive-by appraisal." A drive-by means an appraiser doesn't even inspect the home in person. A full appraisal costs more (about $300 vs. $150), but your home's value will be more accurately assessed. Since a sale may be contingent on your home's assessed value and it determines how much you can borrow against your home and how much you'll pay in property taxes, accuracy is important.
• Don't pay an application fee. A lot of companies are waiving that fee, so you shouldn't be subject to it.

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