Your Mortgage : As Fixed-Rate Mortgage Rates Dip, Fewer Buyers Opt for Adjustables


With fixed-mortgage rates near their lowest point of the decade and adjustable-rate mortgages offering consumers less initial savings, a growing number of home buyers are rejecting the call to ARMs and once again opting for fixed-rate loans.

Adjustables are usually popular with consumers when interest rates are high and introductory rates on ARMs are at least two points below those offered on fixed-rate mortgages. But the average introductory rate on ARMs now stands at about 8 3/4%, according to the Federal Home Loan Mortgage Corp., and consumers can easily find fixed-rate loans at 10%--a difference of little more than a point.

"People are looking at the numbers and saying, 'The money I could initially save by choosing an ARM just isn't worth the risk involved in having a loan with a rate that could move up real fast," said Peter G. Miller, author of "The Common Sense Mortgage."

"Frankly, I don't blame them. If I were looking for a mortgage today, I'd choose a fixed over an adjustable."

Miller isn't alone: In a turnaround from just a few months ago, many financial experts are telling consumers who are loan-shopping today to choose a fixed-rate loan over one whose interest rate will vary.

Rate Likely to Change

Although fixed-rate loans are hovering around the 10%-mark and many lenders are offering ARMs with an introductory rate under 9%, it's important to remember that the ARM rate will likely change at the first adjustment period--usually in six or 12 months. When that happens, the loan rate could easily go higher than 10%--higher than today's fixed-rate loans.

Of course, fixed-rate loans offer other advantages. "There's the comfort of knowing that your rate and your monthly payment will never change, even if inflation takes off," Miller said. "That makes budgeting a bit easier and might also let you sleep better at night."

Home buyers seem to like all those advantages. When fixed rates stood above 11% earlier this year, about 54% of the public opted for adjustable-rate mortgages, according to the federal Office of Thrift Supervision. But now that fixed-rate loans can be found for about 10%, only 27% are choosing ARMs.

It's a trend that many experts say will continue, in part because mortgage rates are expected to drift upward through much of next year. Borrowers who take out fixed-rate loans today won't feel the effects of the expected increases: Buyers who choose adjustable-rate loans will.

Although ARMs may have lost some of their luster, they're still attractive to certain types of buyers.

Short-Term Stay

"If you can barely qualify for a loan, you might want to choose an adjustable-rate mortgage over a fixed-rate loan because the lower initial rate on the ARM will make it easier to get the money," said Mark Obrinksy, senior economist for the Federal National Mortgage Assn. in Washington.

"Or, you might want to choose the ARM if you're only going to be in your house for one, two or three years. You'll get the savings provided by the ARM's low initial rate, and you'll probably have moved by the time it's adjusted all the way upwards."

If an ARM still looks attractive, remember that your interest rate will be periodically adjusted based on changes in an index specified by the lender. One of the most popular is the 11th District cost of funds index, a composite figure that reflects rates the Federal Home Loan Bank charges lenders for a variety of different loans.

Other popular ARMs are linked to the more volatile index of one-year Treasury securities. Still others are pegged to long-term Treasuries, the prime rate or more obscure indexes.

If you disbelieve most economists and think rates are headed for a sharp downturn, choose an ARM linked to one-year Treasuries because the index reacts more quickly to interest-rate swings. But if you think rates are headed higher or you don't want wild fluctuations each time your rate is adjusted, consider an ARM that's linked to the slower-moving cost-of-funds index or five-year Treasury index.

Lender's 'Spread'

Also remember that all lenders slap on a markup, or "spread," on the index once the introductory rate has ended. If the index rate is 8 1/2% and the lender's spread is two points, your new rate will be 10 1/2%.

"If the lender wants a spread that's more than two or 2 1/2 points, it's best to look somewhere else," said Lawrence A. Krause, president of a San Francisco-based financial planning firm that bears his name.

Also look for a loan that has a five- or six-point limit, or "cap," on how high the rate can go over the life of the loan. So, if the introductory rate is 8.5% and the loan has a five-point cap, your interest rate will never go above 13.5%.

Remember, too, to see what kind of cap is put on the periodic adjustments. Generally, it's best to look for an ARM that can't be adjusted more than one or two percentage points at each adjustment period.

For example, if your ARM currently has a 9.5% rate, a two-point cap on the periodic adjustments would prevent your loan from rising above 11.5% the next time it's changed--regardless of how high rates might go between now and then.

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