There are two types of refinancing options: Fixed Rate Mortgages and Adjustable Rate Mortgages. Each has their own set of pros and cons that you should be aware of before you make a decision.

Fixed Rate Mortgages: The Pros

  • Rates and payments remain will remain the same for the outset.
  • A fixed rate mortgage allows homeowners to manage their budget more effectively.
  • Fixed rate mortgages are easy to comprehend.

The Cons

  • In order to take advantage of falling rates, fixed-rate mortgages may be refinanced. That means a few thousand dollars more in closing costs are incurred.
  • There are no payments early in the term of the loan. This can pose a financial burden for homeowners.
  • Fixed rate mortgages are the same from lender to lender. However, most financial institutions sell their fixed-rate mortgages into the secondary market. As a result, adjustable rate mortgages can be "customized for individual borrowers, while most fixed-rate mortgages can't."

Adjustable Rate Mortgages: The Pros

  • An adjustable rate mortgage allows for lower rates and payments early in the term of the loan. This allows qualified homebuyers to purchase homes they could not otherwise afford.
  • An ARM allows the borrower to take full advantage of the lowest rates without refinancing. This means that as the rates drop, so do the monthly payments without having to pay the fees associated with refinancing.
  • New homeowners tend to save more money.

The Cons

  • With an adjustable rate mortgage, rates can increase at any time during the life of the loan. (The sub-prime mortgage crisis is all the evidence you need).
  • Most borrowers find ARMs too difficult to understand, leaving them to the mercy of the lender.
  • In conjunction with ARMs, there is what is called a "negative amortization loan." This means that you can end up owing more money. How? If the initial payments were set so low that it covered only partial of the interest rate, the balance will be added to the principal.

The more you know about these two refinancing options, the better equipped you will be to decide which one works best for you.