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San Diego real estate library
Choosing a Fixed or ARM Option
One of the most crucial decisions a homeowner will have to make
when choosing to re-finance their home is whether they desire 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 the same
and an ARM is a mortgage where the interest rate changes. The
amount the interest rate moves is normally tied to an index such
as the prime index. Additionally there are normally clauses
which prevent the interest rate from rising or plummeting
dramatically during a particular period of time. This safety
clause supplies protection for both the homeowner and the
lender.
Plusses of a Fixed Option
A fixed re-financing option is best for homeowners with
sufficient credit who are able to lock in a desirable interest
rate. For these homeowners the interest rate they are able to
retain makes it worthwhile for the homeowner to re-finance at
the new interest rate. The major asset 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 change during the course of the loan period.
Negatives of a Fixed Option
Although the capability to lock in a desirable interest rate is
an benefit it can also be considered a downside. 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 excess closing costs when they
re-finance again.
Advantages of an ARM Option
An ARM re-finance option is favorable 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 contemplate 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 number of different elements and
may rise unexpectedly at any time despite the predictions by
industry professionals.
A homeowner who can predict the future would be able to decide
whether or not an ARM is the perfect re-financing option.
However, since this is not possible homeowners have to either
depend 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 disadvantage to an ARM re-financing option is
that the interest rate may lift significantly and unexpectedly.
In these situations the homeowner may unexpectedly find
themselves paying significantly more each month to compensate
for the increased interest rates. While this is a negative,
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 certain percentage over a specific
period of time.
Consider a Hybrid Re-Financing Option
Homeowners who are unsure and find particular features of fixed
rate mortgages as well as particular aspects of ARMs to be
appealing may consider a hybrid re-financing option. A hybrid
loan is one which combines both fixed interest rates and
adjustable interest rates. This is often done by supplying a
fixed interest rate for an introductory period and then adapting
the mortgage to an ARM. In this option, lenders usually provide
introductory interest rates which are extremely enticing to
persuade homeowners to pick this option. A hybrid loan may also
work in the opposite way by offering an ARM for a particular
amount of time and then adapting 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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