It’s Time to Reevaluate Adjustables
After the Federal Reserve’s latest interest rate move, the mortgage market has an unlikely new wrinkle that you shouldn’t ignore.
For the first time in many months, some of the most attractive deals for home buyers and refinancers can be found in adjustable-rate loans rather than fixed-rate mortgages.
In the days immediately following the Fed’s latest 0.5% rate cut, fixed-rate, 30-year home loans actually rose slightly in price while adjustable-rate mortgages declined. That phenomenon has created new opportunities for sharp-eyed borrowers to lock up 57/8% to 61/2% mortgage money, with minimal points or fees.
The Fed’s rate cut was aimed only at the cost of short-term money. It had no direct effect on 30-year home mortgages, whose rates tend to track long-term bonds.
In an indirect way, however, it might have nudged up 30-year loan rates, as investors began to anticipate stronger economic growth--and inflationary pressures--later in 2001.
Where the Fed’s move made a big splash for home buyers and refinancers was in the segment of the market tied directly to short-term rates--adjustable-rate mortgages (ARMs). Almost immediately after the rate cut, the gap between ARMs and 30-year fixed-rate mortgages billowed to more than 11/3 percentage points, the biggest spread in 2001.
According to Freddie Mac, the giant mortgage investor, 1-year Treasury-indexed ARMs dropped to an average 5.81% after the Fed’s move. Fixed-rate 30-year loans, by contrast, rose to 7.14%. As recently as January, the gap between fixed-rate and adjustable-rate mortgages was microscopic--just 0.21%. That was nowhere near enough to make ARMs attractive, and in fact, not many home buyers or refinancers applied for them.
But now, with a relatively plump 11/3 percentage point advantage over competing fixed-rate loans, it’s time for some loan applicants to seriously check out adjustables again.
As Frank Nothaft, Freddie Mac’s deputy chief economist, put it in an interview: “Why pay for 30-year mortgage money” at a premium price if you don’t need to?
Which Buyers Should Consider Adjustables?
Who’s best positioned to take advantage of the short-term rate drop? Borrowers who expect to be in their homes for a limited number of years, whether because of likely job transfers, family growth, impending empty-nesterhood or other foreseeable changes. First-time home buyers and downsizers are excellent candidates for loans tied to short-term rates, says Nothaft.
What’s available for them out there right now? In last week’s marketplace of 7% to 71/4% fixed-rate mortgages, some aggressive lenders were pricing so-called “hybrid” ARMs at or under 6% with zero or minimal points. (A point equals 1% of the loan amount.)
A hybrid ARM offers a blend of adjustable-and fixed-rate features. It carries a fixed rate for an initial period of time, typically from three to seven years, followed by rate adjustments once a year for the balance of the 30-year loan term.
Many people who sign up for a hybrid ARM do so to reap the benefit of the initial, low fixed-rate period, and expect either to move, sell the house, or refinance before the rate adjusts.
Normally, three-year hybrid ARMs cost less than five-or seven-year hybrids. A random sampling of Internet quotes last week turned up plenty of three-year hybrids at or below 6%, with anywhere from zero points to one point. Five-and seven-year hybrids went for anywhere from 61/4 to 63/4%, with zero to one point.
One-year, traditional Treasury-indexed ARMs were the cheapest of all--5% with less than one point from some sources. But of course that guarantees you just one year at the 5% rate; if rates rise next year, you could be paying up to 7% on your mortgage, and possibly even more the following year. With a three-year hybrid at 6% and zero points, you’re guaranteed that rate for the first three years.
Are there some pitfalls to hybrids? Absolutely. Here a few pointers:
* Rates. Don’t be dazzled by a lender’s low, posted rate--say 51/4% on a three-year hybrid. What fees and points come with that rate? It’s often smarter on a short-term hybrid ARM to shop for the lowest rate carrying zero points. That’s because the effective cost of upfront points is always greater over a shorter period.
* Junk fees. Be on guard for large “processing,” origination and other mumbo-jumbo fees that aren’t mentioned on lender rate sheets, but get loaded on at settlement. They have the same impact as points on the true cost of your loan, and weigh heavier on short-term borrowers than long-term.
* Prepayment penalties: avoid them if you can.
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Distributed by the Washington Post Writers Group.
