Trading in an ARM for the long haul may still make sense
There may still be time to trade in that adjustable-rate mortgage for a decent fixed-rate loan.
To be sure, rates on 30-year fixed mortgages have shot up from around 5.6 percent in the summer of 2005 to around 6.6 percent today, according to the mortgage company Freddie Mac. But many adjustable-rate mortgages, or ARMs, may reset later this year to around 7.5 percent, says Greg McBride, an analyst with Bankrate.com.
While rates on 30-year fixed mortgages are at a four-year high, they're still well below the 20-year average of nearly 8 percent, McBride notes. And in case you haven't noticed, long-term interest rates are falling again. The yield on 10-year treasury notes has slipped from 5.19 percent earlier this month to around 5.03 percent this week. Since mortgage interest rates are influenced by long-term treasuries, don't be surprised if mortgage rates also dip. If they do, this might offer borrowers with adjustable-rate loans yet another opportunity to lock in a fixed-rate mortgage at a reasonable rate.
Now, if you currently have a hybrid ARM, such as 5-1 adjustable-rate loan—in which the first five years are fixed and the rate floats starting in the sixth year—don't rush to refinance just yet, says Keith Gumbinger, vice president of the mortgage research firm HSH Associates.
If you took out a 5-1 ARM in May 2004, he says, you probably locked in a rate of around 5.4 percent. That means you will be paying considerably less than the prevailing market rate until May 2009. And by then—or perhaps even sooner—mortgage rates could fall if the Federal Reserve Board is forced to slash rates to stimulate the economy.
"So there's no compelling reason for these folks to jump out and refinance," Gumbinger says.
If you're shopping for a new mortgage to buy a home, stick with a fixed-rate loan. Right now, the so-called mortgage yield curve is pretty flat. For instance, while a 30-year fixed-rate loan might charge you around 6.6 percent, a new 5-1 ARM might charge you nearly as much—around 6.4 percent, according to Gumbinger.
Historically, 5-1 ARMs have offered borrowers a 0.7 percentage-point advantage in interest rates. But today, the gap is only around 0.2 percentage points.
"As a borrower, you have to look at the risk-reward trade-off," says McBride. "And right now, you're not getting much reward for the risk of bearing an adjustable-rate mortgage."
So, a 30-year fixed-rate loan looks like your best bet.