With loan rates so low, now might be a good time to shed ARM

Q Here's my situation: I have a one-year adjustable rate mortgage. My rate last year was 4.125 percent. This year my rate is 3.5 percent. So far, this has been a very good deal for me. I bought the house in 2004 for $319,000; my mortgage is $135,000. I have a lot of equity in the house and could pay off the loan if I had to. Should I just ride this out? Or should I refinance at actually a higher rate than I'm paying right now?

NEIL, NEW PRAGUE

A Your experience with an adjustable rate mortgage (ARM) reflects the fact that yields on the common benchmarks used for resetting ARMs have fallen to their lowest levels in decades. That's good for your cash flow. It also means that the much-feared financial Armageddon around ARM resets this year won't happen.

But how vulnerable are your finances if interest rates rise when the economy picks up? It's likely that rates will head higher once the recovery is apparent. For most people with ARMs, the best counsel is to lock in today's low rates with a fixed rate. It pays to get rid of the uncertainty built into an ARM. Yes, you'll pay a slightly higher interest rate. But you'll be taking advantage of the lowest rates for 30-year, fixed-rate mortgages in a half-century. You'll know what your financial obligation will be a year from now, three years from now, etc. You can always refinance if rates tumble. An ARM is simply too risky a loan for a majority of homeowners, especially compared with the fixed-rate alternative.

That said, there's a wrinkle with your situation. Unlike most homeowners, you say you have enough cash on hand to pay off the mortgage quickly if you wanted. If that's the case, I would consider sticking with the low-rate ARM. You could always get rid of the mortgage if rates start climbing too high for your financial comfort. In other words, you could gamble that rates will stay low. And if you're wrong, you can eliminate the risk of the ARM by paying it off. I'd only go this route after you've satisfied yourself that you have good job security and after examining other potential draws on your savings.