Making a decision to refinance a mortgage with a 30 year fixed rate or a 5/1 ARM is not an easy decision and there is no one correct answer to which is better. There are a number of factors to consider when making this important decision and the right decision depends on number of factors related to the homeowners financial situation and reasons for refinancing. Before homeowners even begin to worry about the type of mortgage they want, they should carefully evaluate their reasons for refinancing in the first place. This article will provide functional definitions of the two types of mortgages and outline the advantages and disadvantages of each type of mortgage. Many homeowners refinance their mortgage on a regular basis, sometimes as often as every four years. There are a number of common reasons why homeowners wish to refinance their mortgage. Some of these common reasons include: Debt consolidation
Lower interest rates
Modify the mortgage terms
Change in financial situation
Accelerate home equity Each of the above mentioned reasons are valid motives for making a change and can increase the quality of life for the homeowners. Debt consolidation loans enable the homeowner to incorporate credit card debt and other debts into new mortgage. Lower interest rates give the homeowner the opportunity to save thousands of dollars over the course of their loan. Modifying the mortgage terms can also be beneficial to the homeowner. A longer term will reduce monthly payments while a shorter term loan will allow the homeowner to build equity quicker and pay less in interest during the course of the loan period. A change in financial situation may also warrant a mortgage refinancing. In general refinancing may be a worthwhile endeavor for homeowners who have improved upon their financial situation but even homeowners who have endured a bankruptcy may qualify for a beneficial refinancing. Accelerating the equity building in the property is another reason to refinance. Homeowners can achieve this effect by reducing the length of their mortgage. Their monthly payments will be higher but they will be paying more towards their principle or second mortgage than they would with a longer loan period. Deciding to Refinance a Mortgage Making the decision to refinance a mortgage is a difficult one. Homeowners should consider the cost of refinancing as well as the length of time they intend to live in the house after refinancing. The amount of time the homeowners plan to stay in their home after refinancing is significant because although refinancing usually results in long term cost savings, it is often necessary for the homeowner to remain in the house for a few years before enjoying the benefits of refinancing. The cost of refinancing should also be considered. Refinancing costs may include typical closing costs such as loan origination fees, title, appraisal, inspection and any other fees associated with refinancing. Refinancing is only a worthwhile endeavor if the overall savings are estimated to exceed the cost of refinancing during the course of time the homeowner will remain in their home. The Advantages and Disadvantages of the 30 Year Fixed Mortgage The concept of the 30 year fixed mortgage is fairly simple to understand. As the name implies the interest rate on this mortgage is fixed meaning the interest rate at the start of the loan agreement will not change during the loan period. The advantage to this type of loan is stability and predictability. Homeowners who opt for this type of loan can expect their mortgage payment to remain constant for the duration of their 30 year loan period. This type of mortgage is ideal for homeowners who do not want to take the risk that their mortgage rate will increase, want the stability of invariable mortgage payments and are planning to remain in their home for a long period of time. The 30 year fixed mortgage is advantageous for homeowners who do not want to take any risks in their homeownership. However, the downside to a 30 year fixed mortgage is the fixed interest rate is usually higher than the initial interest rate for adjustable rate mortgages (ARM). The Advantages and Disadvantages of the 5/1 ARM A 5/1 ARM is a mortgage in which the interest rate remains fixed for the first five years of the mortgage. Subsequent to this initial period of fixed interest rates, the interest rates are adjusted annually. The new interest rate will depend on a number of factors including the current state of the economy. As a result predicting the mortgage rates five years from the start of the mortgage can be a difficult task. The most notable advantage to a 5/1 ARM is the interest rate during the first five years is typically lower than the interest rates offered to homeowners seeking a fixed interest rate mortgage. This adjustable rate mortgage is ideal for homeowner who plan to pay off the loan in its entirety during the initial five years of the mortgage, are willing to take the risk of potential higher interest rates once the fixed period ends or intend to sell their property during the course of the fixed interest rate. The major disadvantage to a 5/1 ARM is the unpredictability of the interest rates after the first five years of the loan agreement. Interest rates can skyrocket during the course of the first five years resulting in a drastic increase in payments when the interest rate becomes variable. Conclusion Choosing a refinancing option is clearly a complicated process which should be carefully considered before making a decision. In general a 30 year fixed mortgage would be ideal for homeowners who do not want to deal with the unpredictability of a variable interest rate. Conversely homeowners who are not concerned with the potential for an interest rate which may drastically increase after the initial five years may prefer a 5/1 ARM. To get a better understanding of mortgage options or to a complete overview of home equity loan programs for subordinate financing please reference Second Mortgage Refinancing |
