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Your Money Outlook: Adjustable mortgages
look good -- but only temporarily
By Greg
McBride • Bankrate.com
Fixed mortgage rates moved below 7 percent for the first time since
March and for just the second week overall this year, as home buyers
continue to benefit from lingering economic concerns. The driving
force behind this move is the notion that, despite six interest
rate cuts by the Federal Reserve this year, the economy has so far
failed to bounce back and the threat of a recession still looms.
Lower rates have not been confined just to fixed mortgages
but to adjustable-rate mortgages as well. Because these loans feature
an annual adjustment, their rates more closely track short-term
interest rates. Federal Reserve Board actions also affect short-term
rates, so with the board steadily cutting rates, adjustable mortgages
have followed suit. Thus far in August, the rates on adjustable
mortgages have fallen to the lowest in the past two years and are
likely to head lower. With the decline in short-term rates, some
borrowers with adjustable mortgages are seeing their rates adjust
lower. Rest assured, this is a temporary phenomenon brought on by
the sharp reduction in interest rates in the past year. After all,
even a broken clock is correct twice each day.
While the spread between fixed and adjustable rates
is now triple what it was in early February, it is still narrower
now than at any point in the 1990s. Home buyers often opt for the
low initial rate and monthly payment of an adjustable-rate mortgage
in hopes of "growing into" the inevitably larger payment
on a fixed-rate mortgage in future years. To do so at this point
could be a huge mistake. While adjustable rates are low, fixed-rate
mortgages are more than one percentage point below the long-term
average of 8 percent. What's more, these low fixed rates represent
permanent payment affordability. Home shoppers unable to afford
the monthly payments on their dream house now have no guarantee
of ever being able to do so.
The short-term benefit provided by an adjustable-rate
mortgage pales in comparison to the longer-term risk of higher rates.
The attractive level of fixed-rate mortgages, relative to both long-term
averages and adjustable-rate mortgages, eliminates any dilemma of
choosing between the two.
Greg McBride is a financial analyst
for Bankrate.com. For advice regarding your specific situation,
please e-mail one of Bankrate.com's
Q&A experts or visit the Personal Finance Advice channel on Bankrate.com.
-- Posted: Aug. 17, 2001
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