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One of the most crucial decisions a homeowner will have to make when deciding to re-finance their home is whether they want 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 illustrative but in essence a fixed rate mortgage is a mortgage where the interest rate remains stable and an ARM is a mortgage where the interest rate varies. The amount the interest rate varies is typically tied to an index such as the prime index. Furthermore there are usually clauses which prevent the interest rate from rising or dropping significantly during a specific period of time. This safety clause provides protection for both the homeowner and the lender.

Advantages of a Fixed Option

A fixed re-financing option is ideal 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 retain makes it worthwhile for the homeowner to re-finance at the new interest rate. The main benefit to this sort of re-financing options is steadiness. Homeowners who re-finance with a fixed mortgage rate do not have to be concerned about how their payments may differ during the course of the loan period.

Disadvantages of a Fixed Option

Although the ability to lock in a favorable interest rate is an advantage it can also be considered a drawback. This is because homeowners who re-finance to obtain a favorable interest rate will not be able to take benefit of subsequent interest rate drops unless they re-finance again in the future. This will cause the homeowner incurring additional closing costs when they re-finance again.

Advantages of an ARM Option

An ARM re-finance alternative is favorable in situations where the interest rate is expected to drop in the near future. Homeowners who are skilled at predicting trends in the economy and interest rates may take into account re-financing with an ARM if they expect the rates to drop during the course of the loan period. But, interest rates are tied to a number of different factors and may rise suddenly at any time regardless of the predictions by industry experts.

A homeowner who can foresee the future would be able to determine whether or not an ARM is the best re-financing option. Still, in view of the fact that this is not possible homeowners have to either rely on their instincts and hope for the best or select a less risky alternative for instance a fixed interest rate.

Disadvantages of an ARM Option

The most understandable drawback to an ARM re-financing alternative is that the interest rate may rise significantly and suddenly. 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 drawback, there are some elements 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 definite percentage over a specific period of time.

Consider a Hybrid Re-Financing Option

Homeowners who are in doubt and find certain aspects of fixed rate mortgages as well as certain aspects of ARMs to be appealing might consider a hybrid re-financing alternative. A hybrid loans is one which combines both fixed interest rates and adjustable interest rates. This is often done by offering 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 encourage homeowners to prefer this option. A hybrid loan may also work in the opposite way by offering an ARM for a particular amount of time and then converting the mortgage to a fixed rate mortgage. This version can be quite risky as the homeowner may find the interest rates at the conclusion of the introductory period are not favorable to the homeowner.

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