Jane Smith can also refinance into a 6 percent FRM but her ARM rate is 5 percent, it adjusts in a year, and she expects to be in her house for 10 years. Further, she has a higher margin on her ARM than Doe, which will result in a 6.5 percent rate at the next rate adjustment if the market index does not change. It turns out that even if rates are stable in the future, Smith will do better with the FRM.

These are extreme examples and most borrowers will fall between them, which makes the decision process more difficult. To make it manageable, Chuck Freedenberg and I have developed a new calculator, number 3e in the menu of calculators on my Web site. It pulls together all the factors relevant to the decision, and generates one bottom-line number: the net dollar savings or cost from switching from ARM to FRM over the borrower's time horizon.

Here are some of the major factors the calculator uses:

Time Horizon: In general, the longer the borrower expects to remain in the house, the stronger the case for the refinance. More bad things can happen to the ARM over a longer period.

ARM Features: Refinance is a less attractive option for ARMs with particularly desirable features. These include a low current rate, a long period to the next rate adjustment, a low rate adjustment cap, a low maximum rate, and a small margin. Note: The margin is added to the rate index to determine the new rate on an adjustment date, subject to the adjustment cap and maximum rate.

FRM Features: The rate on the new FRM will be higher than the ARM rate, but much depends on how much higher it is. Further, account must be taken of refinance costs, including points, other lender fees and other settlement costs, all of which reduce the benefit of a refinance.

Prepayment Penalty: A prepayment penalty on the ARM acts just like an additional fee on the FRM, since you only pay it if you refinance.

Mortgage Insurance: If the borrower is paying for mortgage insurance on the ARM but the house has since appreciated, the FRM might not require the insurance. Even if it is required, the premiums on FRMs are lower. This would be a partial offset to the costs of the FRM.

Assumptions About Future Interest Rates: A critical factor affecting the results is the assumption you make about future interest rates. Calculator 3e allows you to assume many different future rate patterns, including the "stable index" and "worst case" assumptions used in my illustrations above. Another approach is to specify a rate increase each year, beginning in a specified year, and continuing for a specified number of years.

One decision strategy is to try rising-rate scenarios of increasing severity until you find the one in which the costs of the ARM and FRM in your case are about the same. This tells you how big a rise in rates is required to make refinance into an FRM profitable for you.

If I did this, for example, and found that any increase in rates greater than .5 percent per year for three years made the refinance profitable, I would refinance. If I found that it took a 2 percent rise each year for five years for the refinance to be profitable, I would stay with my ARM. If the results fell between these two, I would consult my astrologist.