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.
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