Home Economics: Homework needed before choosing adjustable-rate loan

THERESA DOFFINGFresno Bee
THERESA DOFFINGFresno Bee
Posted: May 06, 2011

Fixed mortgage rates remain below 5 percent, and these days fewer and fewer home buyers seem to be opting for adjustable-rate loans.

The average interest rate for a one-year ARM was 3.14 percent Thursday, according to Freddie Mac. The 30-year fixed rate was 4.71 percent.

But low fixed rates aren't the only reason that adjustables are financing just 7 percent of all home-purchase loans, according to figures from Freddie Mac, which tracks them.

"Home buyers have shied away from ARMs because they are wary of the risks . . . the potential for much larger payments if future interest rates are significantly higher," said Freddie Mac chief economist Frank Nothaft.

In 2004, adjustables' share of all loans reached a high of 36 percent. Their low point came in early 2009, when just 2 percent of all mortgages were ARMs. Nothaft said he believed the share would rise to 9 percent this year.

Basically, an adjustable-rate mortgage is a loan with an interest rate that changes. ARMs may start out with lower monthly payments than fixed-rate mortgages, but the Federal Reserve advises borrowers to consider these points:

Monthly payments on the loan can go up, maybe by a lot, even if interest rates do not increase. And payments may not go down much, or at all, even if interest rates drop.

You can end up owing more money than you borrowed, even if you make all your payments on time.

An early payoff in the hope of avoiding higher payments might incur a penalty.

If you plan to buy a house this year, should you consider an adjustable-rate mortgage?

Opinions differ.

Peter Buchsbaum, branch manager at Gateway Funding/Arlington Capital in Horsham, isn't a fan of adjustables, believing that, in light of low fixed rates, the risk isn't fiscally responsible.

"Five years ago, had I offered a client a cheaper rate for a five-year adjustable because he said he was moving in five years, that borrower would now be in harm's way," Buchsbaum said. "I learned a long time ago that my crystal ball has stopped working. I only know what now is."

Rates will always change, he said, adding, "If my client asked me to lend them money on a shorter term because he or she felt it prudent, I would make sure there was a lifetime rate cap."

A lifetime cap is the maximum interest rate that may be charged at any point on an adjustable-rate mortgage. For example, if an ARM has an initial interest rate of 5 percent and a lifetime cap of 5 percent, the maximum rate that may be charged is 10 percent.

"Interest rates are so reasonable today, and the values are so much more reasonable than three years ago," Buchsbaum said. "Why not buy your home for a longer term and live in it like a home, rather than an investment vehicle?"

Bankrate.com mortgage columnist Holden Lewis said there weren't many circumstances in which it was wise for a middle-class person to buy a house using an ARM.

"It makes sense for buyers who are certain that they will sell the house within a year or two of the end of the fixed-rate period," he said.

Lewis offered this example: "A 5/1 ARM has an introductory rate that is fixed for the first five years. If the buyer is sure that he or she will sell the house within six or seven years, then maybe it's better to get an ARM."

A young professional - a newly minted lawyer or doctor or banker who expects income to skyrocket within a few years - might get an adjustable for a house that would be unaffordable with a fixed-rate loan but will be affordable once income rises, Lewis said.

"But under today's stricter lending guidelines, that borrower will have trouble qualifying for a loan," he said. "Maybe it's better to buy a starter home at the beginning, even for tomorrow's 'Masters of the Universe.' "

Harry Pecci, a loan officer with Prosperity Mortgage in Doylestown, said an adjustable would make sense "if you were fairly certain that you would not be in the home for more than the fixed period of the ARM."

"I've generally been a big fan of ARMs, statistically speaking," Pecci said. "Most people will refinance or move within six or seven years, and the saving in the meantime is significant."

Based on Thursday's rates, a $200,000 mortgage with an adjustable rate will save the borrower $166 a month compared with a fixed-rate loan, he said.

Federal Housing Administration ARMs have an advantage over conventional adjustable loans, Pecci said, because you qualify at the lower rate, for more purchasing power, and the rate cap is 1 percent per year after the adjustment year, with a 5 percent lifetime cap.

"It is not until year eight or nine that your total payments on an FHA adjustable would exceed what you'd have paid if you had started out with a 30-year fixed," he said.

Pecci warned that conventional ARMs typically had a 5 percent rate cap but "with the full 5 percent increase in rate possibly hitting you in the adjustment year."

For example, with a 5/1 ARM, your rate could go from 3.375 percent to 8.375 percent in year six.

Lewis said that though many lenders say adjustables are cheaper in the long run, "those monthly payments are short-run phenomena."

"With a fixed-rate loan," he said, "you know what your monthly payments will be years from now."


Contact real estate writer Alan J. Heavens at 215-854-2472, aheavens@phillynews.com or Twitter: @alheavens.

 

comments powered by Disqus
|
|
|
|
|