Picking a Fixed or ARM Option
One of the most important decisions a homeowner will
have to make when deciding 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 options. The names are pretty much self
explanatory but basically a fixed rate mortgage is a
mortgage where the interest rate stays steady and an ARM
is a mortgage where the interest rate moves. The amount
the interest rate varies is normally tied to an index
such as the prime index. Additionally there are
generally clauses which prevent the interest rate from
lifting or dropping dramatically during a specific
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 best 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 useful for the homeowner to
re-finance at the new interest rate. The large advantage
to this sort 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
shift during the course of the loan period.
Disadvantages of a Fixed Option
Although the capability to lock in a favorable interest
rate is an advantage it can also be considered a
disadvantage. This is because homeowners who re-finance
to obtain a favorable interest rate will not be able to
take advantage of subsequent interest rate falls unless
they re-finance again in the future. This will result in
the homeowner incurring additional closing costs when
they re-finance again.
Benefits of an ARM Option
An ARM re-finance option is desirable in situations
where the interest rate is expected to drop in the near
future. Homeowners who are talented at predicting
patterns in the economy and interest rates may think
about re-financing with an ARM if they expect the rates
to plummet during the course of the loan period.
However, interest rates are tied to a number of varying
parts and may lift 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 best re-financing
option. However, since this is not feasible homeowners
have to either depend 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 lift dramatically
and rapidly. In these situations the homeowner may
suddenly 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 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 factors 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 supplying a fixed interest rate for an
introductory period and then converting the mortgage to
an ARM. In this option, lenders typically offer
introductory interest rates which are extremely enticing
to convince 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
pretty risky as the homeowner may discover the interest
rates at the conclusion of the introductory period are
not desirable to the homeowner.
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