Your Mortgage : Time to Trade Your ARM Loan for a Fixed Rate?

If you’re among the 6 million or so homeowners who have an adjustable-rate mortgage that’s tied to the 11th District Cost of Funds (COF) Index, here’s some good news:

The popular rate gauge has hit an all-time low, and it could drop even more over the next few months.

In fact, many homeowners who have ARMs--regardless of whether their loans are linked to the 11th District COF or another indicator--have seen the size of their monthly mortgage payment shrink lately or will see it drop the next time that it’s adjusted.

But while the decline in ARM rates has saved many homeowners money, it has also put them in a quandary:

Is this a good time to “trade in” their adjustable-rate mortgage for the safety and security of a fixed-rate loan, or should they keep their ARM and hope that rates drop even farther?

“That’s a tough question, and there’s no easy answer,” said David Seiders, an economist for the National Assn. of Home Builders.

About a third of all ARMS in the United States are linked to the 11th District COF. It’s the most popular index in the West, and one of the most-used indicators in the country.

The remaining two-thirds of the 18 million or so ARMs are linked to the one-year Treasury bill or more obscure indicators.

The 11th District index is published monthly by the Federal Home Loan Bank of San Francisco. It reflects the composite rate that about 155 Western savings institutions pay on savings and checking accounts and other types of deposits.

The FHLB recently reported that the index fell to 7.155% in June. That was down from 7.329% in May and the lowest it has been since the agency began publishing the figure 10 years ago.

“With inflation low, S&Ls; don’t have to pay as much in order to attract deposits,” said Jerry Waldron, an FHLB vice president.

Since the low inflation rate is allowing lending institutions to pay less on their certificates of deposit and other accounts, Waldron explained, they’re passing along those savings to homeowners who have ARMs.

Further declines could be in the offing. Many economists think that the Federal Reserve, which is in charge of regulating interest rates, will soon push rates down even farther to encourage more investment and jump-start the sluggish economy.

“If you look at some of the key economic indicators, like auto sales and unemployment figures, it’s pretty clear that the economy could use a shot in the arm,” said Leslie Appleton-Young, an economist for the California Assn. of Realtors.

“A cut in the discount rate could be just what the doctor ordered.”

If the Federal Reserve forces overall rates lower, Appleton-Young said, borrowers with ARMs will benefit because their mortgage payments should drop too.

Still, a lot of homeowners aren’t taking any chances. Lenders say that many borrowers are giving up their low-rate ARMs and refinancing with fixed-rate mortgages, which currently hover about 10%.

Even though these homeowners’ monthly payments will go up a bit, they figure that locking in a 10% rate today will prevent them from making much higher payments when the various ARM indexes eventually start to rise again.

But other homeowners are holding on to their ARMs, hoping that the interest-rate decline will continue.

“That’s an especially good strategy if you don’t expect to stay in your home for more than another year or two,” said Sam Lyons, senior vice president of lending giant Great Western Bank.

“Your rate is probably going to continue to drop over the next few months, and you’ll avoid all the costs involved in refinancing.”

Average Rates for Residential Mortgages

Average rates for residential mortgages as of Aug. 2, 1991.

Survey Conventional Mortgages Adjustable Mortgages Area 15 Year 30 Year Composite 1 Year Composite National 9.26% 9.55% 9.41% 7.18% 7.52% California 9.46 9.72 9.60 7.31 7.42 Connecticut 9.25 9.57 9.44 7.09 7.34 Wash. D.C. 9.20 9.46 9.34 6.92 7.32 Florida 9.27 9.58 9.43 7.11 7.42 Mass. 9.23 9.51 9.38 7.11 7.64 New Jersey 9.21 9.49 9.36 7.20 7.72 N.Y. Metro 9.28 9.57 9.44 7.21 7.61 New York 9.36 9.64 9.51 7.26 7.60 N.Y. Co-ops 9.51 9.78 9.72 7.66 8.13 Pa. 9.02 9.36 9.19 7.09 7.34 Texas 9.19 9.46 9.33 7.07 7.32

SOURCE: HSH Associates, Butler, N.J.