When deciding to re-finance their home, one of the most
important decisions a homeowner will have to make is whether they want to
refinance with a fixed mortgage, an adjustable rate mortgage (ARM) or a hybrid
loan that combines the two options.
The names are in practice self explanatory but basically a
fixed rate mortgage is a mortgage where the interest rate remains constant and
an ARM is a mortgage where the interest rate differs.
The amount the interest rate varies is usually tied to an
index such as the prime index.
Additionally there are usually clauses, which
prevent the interest rate from rising or dropping dramatically throughout a
specific period of time. For both the homeowner and the lender, this safety
clause provides protection.
Fixed Mortgage Advantages
For homeowners who are able to lock in a favorable interest
rate with good credit, a fixed refinancing option is ideal. For these homeowners
the interest rate they are able to retain makes it valuable for the homeowner
to re-finance at the new interest rate.
Stability is the major benefit to this
type of re-financing options is stability. Homeowners don't need to be
concerned about the varying amount of payments during the course of the loan
period.
Fixed Mortgage Disadvantages
Although the capability to lock in a favorable interest rate
is an advantage, it can also be measured as a disadvantage.
This is because
homeowners who re-finance to obtain a favorable interest rate will not be able
to make the most of subsequent interest rate drops except in the future, they
re-finance again. This will result in the homeowner sustaining additional
closing costs when they re-finance again.
ARM Advantages
In situations where the interest rate is expected to drop in
the near future, an ARM re-finance option is favorable. Homeowners who are
skilled at foretelling trends in the economy and interest rates may think about
re-financing with an ARM if they expect the rates to drop during the course of
the loan period.
However, since the interest rates are tied to a number of
different factors, they may rise suddenly at any time regardless of the
predictions by industry experts.
A homeowner would be able to determine whether or not an ARM
is the best re-financing option if he can predict the future. However, since
this is not possible homeowners have to either depend on their instincts or
hope for the best or select a less risky option for instance a fixed interest
rate.
ARM Disadvantages
The rising of the interest rate significantly is the most
obvious disadvantage to an ARM re-financing option. In these situations, to
compensate for the higher interest rates, each month, the homeowner may
suddenly find themselves paying significantly more.
While this is a drawback,
for both the homeowner and the lender, there are some elements of protection.
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 certain percentage
over a specific period of time.
Think About A Hybrid Refinancing Option
A hybrid refinancing options is best for homeowners who are
undecided and find certain aspects of fixed rate mortgages as well as certain
aspects of ARMs to be appealing.
A hybrid loans is one, which combines both
fixed interest rates and adjustable interest rates. This is often done by means
of offering a fixed interest rate for an initial period and then converting the
mortgage to an ARM.
In this option, in order to encourage homeowners extremely
to choose this option, lenders typically offer introductory interest rates. A
hybrid loan may also 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.
As
the homeowner may find the interest rates at the conclusion of the introductory
period this version can be quite risky, and are not favorable to the homeowner.
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