When you think about refinancing your mortgage, you probably imagine taking out a new loan with a lower interest rate. It seems obvious -- a lower rate means a reduced monthly payment. In recent months, however, many homeowners are refinancing from adjustable-rate mortgages (ARMs) to fixed-rate loans, which can carry rates up to two percent higher.
Why pay more?
Maybe you think interest rates will go up in the medium term, and you want the stability offered by a fixed-rate mortgage. The last few years have seen the lowest interest rates in a generation, which has led to a huge boom in the real estate market. Many feel these rates are unlikely to stay this low for the long term. "Rates have been bouncing around," says LendingTree's Vice President of Product Management, Dan Moore, "but over the course of the last year and a half, adjustable rates have been rising while fixed rates have stayed very low." If rates do rise sharply, homeowners with adjustable mortgages may be strained by the higher payments.
The effect of market trends
No one can predict market trends with any certainty, but any decision to refinance should take into account your feelings about where rates might be headed. In general, if rates are indeed headed higher, a fixed rate may be a wise choice, while adjustable-rate mortgages are more attractive if rates are dropping or staying level. You're not limited to these two options, however. "Lenders are coming out with new products all the time," says Moore, "because consumers are asking what else is out there besides the traditional mortgages."
Hybrid mortgages
Moore and other experts are seeing more homeowners choosing hybrid mortgages, which combine the features of both fixed and adjustable rates. A 5/1 hybrid mortgage, for example, carries a locked-in rate for the first five years, after which it adjusts annually. What makes these mortgages so attractive is that they offer stability for those first five years, yet carry a lower initial interest rate than a 15- or 30-year fixed-rate loan. If you're thinking about moving in five years or so, refinancing with a hybrid may be an excellent choice. (Hybrid mortgages are also available with three-, seven- and ten-year fixed periods.)
Option ARMs
Another mortgage that Moore suggests is the option ARM, which allows homeowners to choose different payment amounts each month. "The loan is great for people who need the flexibility," he says. "You can really control your cash flow -- if you take the lowest option you can almost cut your payment in half. But remember, there is no free lunch. That amount you save is added to your principal balance, so you may get a surprise later if you don't understand the loan."
As with any borrowing decision, the choice to refinance should start with an understanding of the many mortgage products available. Read about many of your mortgage options in the LendingTree.com Consumer Education Center.
