Choosing a Fixed or ARM Option. Helpful Facts to Consider
One of the most essential decisions a homeowner will have to make when deciding to re-finance their home is whether they want 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 essentially a fixed rate mortgage is a mortgage where the interest rate remains stable and an ARM is a mortgage where the interest rate varies. The amount the interest rate varies is as a rule tied to an index such as the prime index. Additionally there are usually clauses which prevent the interest rate from rising or dropping dramatically during a specific period of time. This security clause provides 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 favorable interest rate. For these homeowners the interest rate they are able to retain makes it useful for the homeowner to re-finance at the new interest rate. The main benefit to this kind of re-financing options is steadiness. Homeowners who re-finance with a fixed mortgage rate do not have to be concerned about how their payments may vary during the course of the loan period.
Disadvantages of a Fixed Option
Although the ability to lock in a favorable interest rate is a benefit it can also be considered a disadvantage. This is because homeowners who re-finance to get a favorable interest rate will not be able to take benefit of subsequent interest rate drops unless they re-finance again in the future. This will cause the homeowner incurring extra closing costs when they re-finance again.
Advantages of an ARM Option
An ARM re-finance choice is favorable in situations where the interest rate is expected to drop in the near future. Homeowners who are skilled at predicting trends in the economy and interest rates may take into account re-financing with an ARM if they expect the rates to drop during the course of the loan period. Though, interest rates are tied to a number of various factors and may rise unpredictably at any time despite the predictions by industry experts.
A homeowner who can foretell the future would be able to determine whether or not an ARM is the best re-financing option. Though, as 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.
Disadvantages of an ARM Option
The most clear disadvantage to an ARM re-financing option is that the interest rate may rise considerably and unpredictably. In these situations the homeowner may suddenly find themselves paying significantly more each month to compensate for the higher interest rates. While this is a disadvantage, there are some elements 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 definite percentage over a particular period of time.
Consider a Hybrid Re-Financing Option
Homeowners who are undecided and find certain aspects of fixed rate mortgages as well as certain aspects of ARMs to be appealing might consider a hybrid re-financing choice. A hybrid loans 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 converting the mortgage to an ARM. In this option, lenders usually offer introductory interest rates which are very enticing to encourage homeowners to prefer this option. A hybrid loan may besides work in the opposite way by offering an ARM for a certain amount of time and then converting the mortgage to a fixed rate mortgage. This version can be rather risky as the homeowner may find the interest rates at the conclusion of the introductory period are not favorable to the homeowner.
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