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The changing market


The real estate "boom" is over, experts say. With change comes both risk and opportunity.

Rate trends: What's ahead in 2006?
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Households with ARMs are currently feeling, or will feel at the next adjustment, the effects of rising interest rates through sharply higher mortgage payments. The full effect of higher rates will be delayed for households that are not facing the first rate adjustment until 2007 or later. As a result, borrowers are moving out of adjustable-rate mortgages and locking in fixed rates that are currently lower than what their adjustable rates will jump to at the next reset.

A common index for adjustable-rate mortgages, the one-year Treasury, could exceed 5 percent by the time the Fed is done raising interest rates. Tack on a margin of 2.5 percentage points, and the borrower is facing a rate of 7.5 percent, perhaps more. For home buyers and existing homeowners alike, fixed-rate mortgages will remain the popular choice as long as fixed rates stay below 7 percent.

Of course, households expecting a sharp increase in income -- upwardly mobile professionals such as doctors, lawyers or small business owners -- may still opt for the adjustable mortgage route if increasing income will offset higher mortgage payments. Not only are these borrowers best-suited to handle any fluctuations in monthly payments, but they could see payments fall several years later if the Fed must begin reducing short-term interest rates at some point.

The Fed is not done raising interest rates, which means rates for home equity lines of credit are still on the "up" escalator. The current rate of 7.5 percent could hit, or exceed, 8 percent by the time the Fed is done raising interest rates. This is much more significant to existing HELOC borrowers that accumulated the balance or initiated a piggyback loan when interest rates were much lower, such as 4 percent. In the meantime, the monthly payments have routinely moved higher, and they now face having to repay the balance at higher rates.

For borrowers looking to begin tapping home equity in 2006, the outlook is much different. With the Fed coming to an end of the rate hikes, presumably in the first half of 2006, new HELOC borrowers may actually benefit if interest rates fall below the current average of 7.5 percent during the period their balance is outstanding. Further rate hikes this year will have a limited impact if borrowers have yet to accumulate significant balances on their lines of credit.

Home equity loans, which offer fixed rates, have been a popular destination for HELOC borrowers looking to avoid interest-rate variability. But 2006 may be a different story. With the Fed close to wrapping up the interest rate hikes, locking in a fixed-rate home equity loan at the current average of 7.5 percent, or a potentially higher rate later this year, may provide only limited benefit by protecting the borrower from rising rates. However the borrower will surrender the ability to benefit if interest rates fall during the repayment period.

If interest rates peak in the middle of 2006 and don't rise further, the payment and borrowing flexibility of a line of credit will remain attractive, relative to a home equity loan where the interest rate and monthly payment are carved in stone.

-- Posted: March 1, 2006
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