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Refinance Tips

Fixed or Variable Rate Mortgage Refinancing?

Choosing between a fixed-rate mortgage (FRM) and variable-rate mortgage, also known as an adjustable-rate mortgage (ARM), is different now than it used to be. At one time, fixed- and adjustable-rate mortgages were only available as 15-year, 20-year and 30-year mortgages. But, now there are also 40-year mortgages, as well as interest only and negative amortization options. These new options provide you with more loan choices. Each has its benefits and downfalls.

Fixed rate loans cost more but offer the certainty of monthly repayments which are manageable. Historically, you'll note that interest rates for home mortgages are usually between 7-percent to 9-percent range. Investopedia indicates that fixed-rate mortgages are easy to understand and vary little from lender to lender, with the down side being that when interest rates are high, it's harder to qualify for a fixed-rate loan.

Variable rate loans typically come with lower introductory rates are based on a publicly-available index (e.g., LIBOR Index, COFI Index, COSI Index, MTA Index, etc.) plus a lender-specified margin (typically 1% - 2%). But, with any adjustable mortgage, you run the risk of interest rates rising and then your payment rises. Sometimes, the amount the payment raises could be more than what you can afford. Some ARMs are structured so that interest rates can nearly double in just a few years. The hybrid ARMs, which have longer fixed periods of three, five, seven or 10 year, are more popular because the introductory rate stays fixed for so much longer.

Interest-only options offer borrowers the opportunity of making interest-only payments on their loans, which can help if the borrower is currently in a slight financial bind. This option is not to be confused with a negative amortization (neg-am) mortgage. This mortgage option allows the borrower to choose from typically one of four payment options.

The minimum payment option doesn’t cover the interest, and if the borrower pays only the minimum, the shortfall is tacked to the principal balance causing the balance to increase (negative amortization) rather than decrease (regular amortization). This is a very risky mortgage, and many lenders discourage borrowers from taking out neg am mortgages unless they are experienced investors or real estate speculators.

To determine which mortgage is right for you, you have to consider the maximum amount you can afford your mortgage payment could increase and compare what might happen with your mortgage costs with your future ability to pay. And, you need to determine how long you plan on staying in your home. ARMs are generally better for those planning on moving soon. And, FRMs usually are better for those who plan to stay 10 years or longer.

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