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 | San Diego downtown real estate brokerBob Schwartz, CRS, GRI Certified Residential Specialist
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Copyright © 2006 by Bob Schwartz Certified Residential Specialist All rights reserved. You may reproduce materials available at this site for your own personal use and for non-commercial distribution. All copies must include this copyright statement. | Choosing a Fixed or ARM Option One of the most crucial decisions a homeowner will have to make when deciding 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 options. The names are pretty much self explanatory but basically a fixed rate mortgage is a mortgage where the interest rate remains the same and an ARM is a mortgage where the interest rate varies. The amount the interest rate moves is usually tied to an index such as the prime index. Additionally there are generally clauses which keep the interest rate from rising or dropping dramatically during a particular period of time. This safety clause provides protection for both the homeowner and the lender. Plusses of a Fixed Option A fixed re-financing option is best for homeowners with satisfactory credit who are able to lock in a desirable 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 significant benefit 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. Downsides of a Fixed Option Although the ability to lock in a favorable interest rate is an benefit it can also be considered a disadvantage. This is because homeowners who re-finance to aquire a desirable 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 desirable in situations where the interest rate is expected to drop in the near future. Homeowners who are able at predicting patterns 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 variety of varying factors and may increase unexpectedly at any time despite the predictions by industry proffesionals. A homeowner who can predict the future would be able to choose whether or not an ARM is the ideal re-financing option. However, since this is not feasible 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 obvious downside to an ARM re-financing option is that the interest rate may rise significantly and rapidly. In these situations the homeowner may unexpectedly find themselves paying dramatically more each month to make up for the higher interest rates. While this is a negative, there are some parts 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 keeps the interest rate from being raised or lowered by a certain percentage over a certain period of time. Contemplate a Hybrid Re-Financing Option Homeowners who are undecided and find certain parts of fixed rate mortgages as well as certain factors of ARMs to be appealing may contemplate 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 providing a fixed interest rate for an introductory period and then adapting the mortgage to an ARM. In this option, lenders typically provide 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 particular amount of time and then changing the mortgage to a fixed rate mortgage. This version can be quite risky as the homeowner may discover the interest rates at the conclusion of the introductory period are not favorable to the homeowner.
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