Selecting a Fixed or ARM Option
One of the most essential decisions a homeowner will have to make when choosing to re-finance their home is whether they wish to refinance with a fixed mortgage, an adjustable rate mortgage (ARM) or a hybrid loan which combines the two choices. The names are pretty much self explanatory but basically a fixed rate mortgage is a mortgage where the interest rate stays constant and an ARM is a mortgage where the interest rate varies. The amount the interest rate changes is generally tied to an index such as the prime index. Additionally there are normally clauses which keep the interest rate from rising or dropping dramatically during a specific period of time. This safety clause offers protection for both the homeowner and the lender.
Advantages of a Fixed Option
A fixed re-financing option is ideal for homeowners with good credit who are able to lock in a desirable interest rate. For these homeowners the interest rate they are able to maintain makes it sensible for the homeowner to re-finance at the new interest rate. The major asset to this kind 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.
Downsides of a Fixed Option
Although the capability to lock in a favorable interest rate is an benefit it can also be considered a disadvantage. This is because homeowners who re-finance to acquire a favorable 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 excess closing costs when they re-finance again.
Plusses of an ARM Option
An ARM re-finance option is desirable in situations where the interest rate is expected to fall in the near future. Homeowners who are able at predicting trends in the economy and interest rates may think about re-financing with an ARM if they expect the rates to fall during the course of the loan period. However, interest rates are tied to a variety of varying factors and may rise unexpectedly at any time despite the predictions by industry experts.
A homeowner who can predict the future would be able to determine whether or not an ARM is the ideal re-financing option. However, since this is not an option homeowners have to either rely on their instincts and hope for the best or select a less risky option such as a fixed interest rate.
Negatives of an ARM Option
The most obvious downside to an ARM re-financing option is that the interest rate may lift considerably and rapidly. In these situations the homeowner may unexpectedly find themselves paying dramatically more each month to compensate for the increased interest rates. While this is a disadvantage, there are some factors 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 particular percentage over a specific period of time.
Consider a Hybrid Re-Financing Option
Homeowners who are undecided and find certain parts of fixed rate mortgages as well as specific elements of ARMs to be appealing might contemplate a hybrid re-financing option. A hybrid loan is one which combines both fixed interest rates and adjustable interest rates. This is commonly done by offering a fixed interest rate for an introductory period and then converting the mortgage to an ARM. In this option, lenders normally offer introductory interest rates which are extremely enticing to encourage homeowners to select this option. A hybrid loan may also work in the opposite way by offering an ARM for a certain amount of time and then changing the mortgage to a fixed rate mortgage. This version can be very risky as the homeowner may realize the interest rates at the conclusion of the introductory period are not desirable to the homeowner.