Been thinking about replacing your adjustable-rate mortgage with a fixed-rate loan to lock in today’s terrific low rates?

Think again. Some ARM holders – not all – might do better staying the course, especially now that the Federal Reserve has reduced short-term interest rates to their lowest levels since the 1950s.

I’ve argued for several years that most people taking out new mortgages are better off with fixed-rate loans for 15- or 30-year terms.

That’s because you can lock in a low rate for the life of the loan – currently just over 6 percent on a 30-year mortgage.

You can get an even lower rate – currently about 4.3 percent – on a new ARM. But since ARM rates change every year, you risk paying higher rates later.

Typically, ARMs can go up (or down) as much as 2 percentage points a year, with a maximum change of 6 points over the life of the loan. So a new ARM starting at 4.3 percent could someday go as high as 10.3 percent. Why shoulder that risk if you can lock in a 6 percent loan with a fixed-rate mortgage?

Rates may decline

On the other hand, if you already have an ARM, there are some other considerations.

Every 12 months, the rate on a typical ARM is adjusted by adding 2.75 percentage points to the rate paid by one-year U.S. Treasury bills on the adjustment date.

As of Nov. 8, those bills were paying about 1.5 percent, thanks to the long series of Fed rate cuts, including the last one on Nov. 6. An ARM with an anniversary this week would, therefore, adjust to 4.25 percent for the next 12 months (1.5 + 2.75).

Factor in closing costs

So the homeowner with the existing ARM adjusting now has this choice: Pay 4.25 percent for the next year, and risk a higher rate later; or refinance to a 6 percent fixed loan and lock the rate in for good.

What tips the balance?

First of all, refinancing costs such as title search, appraisal, points and other closing costs. Why pay thousands to get a new 6 percent mortgage if you can enjoy a 4.25 percent loan for the next year without paying those charges?

The issue is different for someone buying a home and choosing between a new ARM or a new fixed mortgage. Since this borrower is going to pay closing costs regardless of which loan she gets, it probably makes sense to lock in the low fixed rate for the long term rather than gamble on ARM rates staying low.

Other considerations

Homeowners who already have ARMs have a couple of other things to consider:

What is your maximum long-term risk? If you got your ARM in August 2000, for example, you probably started out paying around 7.4 percent. Since you could someday go 6 points higher, to 13.4 percent, it could really pay to refinance to a fixed-rate loan while rates are down around 6 percent.

What do you think rates will do? Short-term rates such as one-year Treasury rates are strongly influenced by Fed policy, and the Fed isn’t likely to raise rates until it thinks inflation is a threat. With the economy sluggish, inflation isn’t much of a danger, so there’s a good chance T-bill and ARM rates will still be low a year from now.

How long will you have the mortgage? The shorter the time, the less risk you take with an ARM.

Suppose you could get 4.25 percent for the next two years? In theory, you could go up to 6.25 percent the year after that, assuming a 2-point annual cap. That means your average for the next three years would be lower than you’d pay with a new fixed mortgage at 6 percent.

In fact, it would take several years of higher rates to wipe out the savings you’d enjoyed in the initial 4.25 percent years. If you think you’re likely to move in next few years, it probably pays to stick with your current ARM rather than pay thousands to refinance.

What can you do with the savings? You could amplify the benefits from a low-rate ARM by putting the monthly savings to work in a good investment. One approach is to use that money for extra principal payments on the mortgage, reducing your outstanding debt.

Each year, the new payment on an ARM is figured by applying the new interest rate to the remaining debt for the number of years left on the loan. By paying down the debt, you reduce the monthly payments required in the future. If you continue to plow money into extra principal payments, you can pay the loan off years ahead of schedule, saving a fortune in interest charges.

Do the math

There are lots of assumptions here, and the only way to make a decision is to run your own figures. Any mortgage lender can tell you the closing costs on a new loan. And you can figure monthly payments on any new or existing loan if you know the size of the debt, the interest rate and number of years for a new loan, or time remaining on an older one.

To do these calculations online, try the tools at www.hsh.com, the site of Butler, N.J., mortgage-information firm HSH Associates. Most financial software programs, such as Quicken and Microsoft Money, also have loan calculators. By running a full amortization table, you’ll be able to see how much debt will remain at the end of every 12 months. Use that to calculate future ARM payments using best- and worst-case assumptions about interest rates.

Or you can figure things the old-fashioned way, with a book listing interest amortization tables. You can find one in the business section of any good bookstore or library.