Choosing refinancing options: Fixed or ARM

When refinancing their homes, house-owners are faced with an important decision – deciding whether to refinance using a fixed mortgage plan, an ARM or adjustable rate mortgage plan or use a hybrid loan that combines features from the other two options.

 

Although the names are quite self-explanatory, the main difference between the two basic plans is that while in a fixed rate mortgage the rate of interest remains unchangeable, in an ARM the rate is variable. The variation of the interest rate is dependent upon some index value like a prime index.

 

Further, to prevent a dramatic rise or fall in the interest rates, several clauses are also put into place regarding the variation. Such safety clauses protect both the lender and the house-owner in case of severe market fluctuations.

 

Advantages from the Fixed Rate Mortgage

Fixed rate mortgages are perfect for those house-owners who have a good credit history and are eligible for low interest rates. Such house-owners find it convenient to refinance their homes at the prevalent interest rate because they can obtain lower rates owing to their credit record. This mortgage options provides the prime advantage of stability. House-owners refinancing with fixed rate mortgages also do not need to worry about variations in monthly payments over the course of their loan period.

 

Disadvantages from the Fixed Rate Mortgage

While locking in a lower and more favorable interest rate is a sure advantage over any other option, it may also prove to be a disadvantage in some cases. House-owners who take out a second mortgage with a fixed interest rate, however favorable it might be, cannot gain any benefits from possible drops in interest rates later during their loan period unless they refinance again. This way they stand to incur additional costs while closing this loan to refinance again.

 

Advantages from the Adjustable Rate Mortgage

ARM refinance options are favorable to house-owners when there is a foreseeable drop in interest rates in the future. House-owners who can predict market trends and rates skillfully can refinance using an ARM if they foresee a drop in the rates of interest in the course of their loan. However, interest rates depend on various unpredictable factors and may increase again without forewarning, in spite of all predictions to the contrary from financial experts.

 

House-owners able to predict the market future should however be able to decide if ARM is a good option for their refinancing plans. Since such a situation is unlikely, leaving house-owners relying on their instincts or crossing their fingers and hoping for a miracle it is better to select a low-risk option like a fixed rate mortgage.

 

Disadvantages from the Adjustable Rate Mortgage

The basic disadvantage of an ARM is that there may be an unexpected and dramatic rise in interest rates due to market fluctuations. In such cases, house-owners may end up paying higher monthly payments because of the sudden increase in interest rates for their mortgage. Although this is a major disadvantage in an adjustable rate refinancing option, house-owners and lenders can seek solace in the safety clause that provides them with protection against enormous changes in the interest rates. Such clauses limit the rise or fall of interest rates by specific percentage amounts for particular periods.  

 

Consider Hybrid Loans as a Refinancing Option

House-owners who cannot decide between fixed rate mortgages and adjustable rate mortgages because of the advantages and disadvantages that both offer can turn to hybrid refinancing as an option. Hybrid loans combine some features of fixed rates and adjustable rates. In such an option, for the introductory time, the loan remains a fixed rate mortgage and converts to an adjustable mortgage after a certain duration.

 

The introductory rates offered by lenders are generally very attractive, enticing customers to sign up for hybrid loans. Hybrid loans also work in the reverse manner with the ARM option being exercised first and then the loan being converted into a fixed rate plan. However, such an option may not be favorable as the rates upon the conclusion of the introductory time may not be suitable for the house-owners financial plans.

 

Recommended Resources:

Choose the Home Refinance Loan Type that makes sense for you
http://www.myfico.com/loancenter/refinance/step2/chooseloan.aspx

Unlock Cash - choosing a fixed or ARM option
http://www.unlockcash.com/choosing_a_fixed_or_ARM_option.html