One of the most necessary decisions a homeowner will have to make when choosing
to re-finance their home is whether they desire to refinance with a fixed
mortgage, an adjustable rate mortgage (ARM) or a hybrid loan which combines the
two options. The names are pretty much self explanatory but basically a fixed
rate mortgage is a mortgage where the interest rate remains the same and an ARM
is a mortgage where the interest rate changes. The amount the interest rate
varies is normally tied to an index such as the prime index. Additionally there
are usually clauses which prevent the interest rate from rising or falling
dramatically during a particular period of time. This safety clause supplies
protection for both the homeowner and the lender.
Benefits of a Fixed Option
A fixed re-financing option is perfect for homeowners with good credit who are
able to lock in a favorable interest rate. For these homeowners the interest
rate they are able to hold makes it valuable for the homeowner to re-finance at
the new interest rate. The large benefit to this type of re-financing options is
stability. Homeowners who re-finance with a fixed mortgage rate do not have to
be concerned about how their payments may change during the course of the loan
period.
Disadvantages of a Fixed Option
Although the capability to lock in a desirable interest rate is an advantage it
can also be considered a disadvantage. This is because homeowners who re-finance
to get a desirable interest rate will not be able to take advantage of
subsequent interest rate drops unless they re-finance again in the future. This
will result in the homeowner incurring extra closing costs when they re-finance
again.
Plusses of an ARM Option
An ARM re-finance option is favorable in situations where the interest rate is
expected to plummet in the near future. Homeowners who are talented at
predicting patterns in the economy and interest rates may consider re-financing
with an ARM if they expect the rates to drop during the course of the loan
period. However, interest rates are tied to a variety of different elements and
may rise unexpectedly at any time despite the predictions by industry experts.
A homeowner who can predict the future would be able to figure whether or not an
ARM is the perfect re-financing option. However, since this is not possible
homeowners have to either rely on their instincts and hope for the best or pick
a less risky option such as a fixed interest rate.
Downsides of an ARM Option
The most obvious disadvantage to an ARM re-financing option is that the interest
rate may rise considerably and unexpectedly. In these situations the homeowner
may rapidly find themselves paying considerably more each month to compensate
for the higher interest rates. While this is a downside, there are some aspects
of protection for both the homeowner and the lender. This often comes in the
form of a clause in the terms of the contract which prevents the interest rate
from being raised or lowered by a specific percentage over a certain period of
time.
Contemplate a Hybrid Re-Financing Option
Homeowners who are unresolved and find specific parts of fixed rate mortgages as
well as certain elements of ARMs to be appealing might consider a hybrid
re-financing option. A hybrid loan is one which combines both fixed interest
rates and adjustable interest rates. This is often done by offering a fixed
interest rate for an introductory period and then adapting the mortgage to an
ARM. In this option, lenders usually supply introductory interest rates which
are extremely enticing to convince homeowners to pick this option. A hybrid loan
may also work in the opposite way by offering an ARM for a specific amount of
time and then adapting the mortgage to a fixed rate mortgage. This version can
be pretty risky as the homeowner may discover the interest rates at the
conclusion of the introductory period are not desirable to the homeowner.
This work is protected under copyright and may not be published in other works without express written permission
Return to Brokerforyou's real estate articles