Fixed vs. ARM

Tuesday, May 16, 2000                             
By Julie Clairmont
Inman News Features 

Mistake: Confusing loan prequalification with pre-approval

“Getting pre-qualified for a mortgage isn't tough. Heck, even bankrupt arsonists can get themselves pre-qualified. And therein lies the problem,” according to “Mortgages for Dummies.”

Don't reflexively grab a fixed-rate mortgage.

Mistake: Using the wrong criteria to pick a loan.

“Some people opt for fixed-rate mortgages because these mortgages have been around longer than adjustable-rate-mortgages (ARMs) and compared to ARMs, fixed-rate loans are easier to understand. Unfortunately, that means some people are using the wrong criteria to select their mortgage loan,” according to the authors.

Right again, says Chris George, president of CMG Mortgage, Inc., based in San Ramon: “Buying a house and getting a mortgage is an ominous prospect, especially for first-time buyers, so a lot of people say: Let's take the variables out of the experience and get a fixed-rate loan.

“In general, he says, many consumers don't understand the dynamics of the mortgage business, which leads to confusion over what type of loan to choose.

“They don't understand that, on average, people change loans every 38 months, that interest rates tend to cycle every three-four years, that political factors and election years tend to affect rates,” he says.

Statistics show again and again that most people don't live in their homes long enough to make a fixed-rate loan the wise choice, says George. To make the right decision, consumers need to do their research and think about the future, not just the present, he says.

“Log on to the Internet and see how the (ARM's) rate compares to others out there,” he advises. He also points out that, history has proven that few ARMs have ever reached their actual life cap rate.

Death, job relocation, the desire to remodel or add a pool are all factors that drive people to refinance or move more often than they tend to predict. “Half the people I sit down with will get divorced,” points out Olson, “which usually means the house will be sold.”

There are some scenarios where a fixed-rate might be preferable, says George.

“They're great when your family is a little further down the path, maybe your kids are in high school, or going to college,” he says.

And some people are simply not comfortable with ARMs, and never will be, say both brokers.

Watch out for mortgage brokers with hidden agendas

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SUNDAY, SEPTEMBER 4, 1994

Real Estate Q & A

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By ROBERT J. BRUSS
SPECIAL TO THE TIMES

 Which Adjustable Rate Index is the Best?

Q: The stock brokerage where I have my account is offering a new home mortgage refinance program for up to 100% of my home’s market value. It would be partially secured to my stock account. But they only offer adjustable rate mortgages tied to the prime rate, CD index or Treasury bill index. Which is best?

A: None of the above. They are all to volatile. The prime rate is an artificial rate, set by the major banks, which rises quickly but declines very slowly. The CD (certificate of deposit) index can also be very volatile. Currently, it is rising rapidly as banks try to regain deposits lost to mutual funds.

The Treasury bill indexes are the most volatile of all. Stay away from an adjustable rate mortgage tied to any of these indexes, or the LIBOR (London Inter Bank Offering Rate).

The only ARM index that I recommend is the cost of funds index (COFI). Often it is called the 11^th District Cost of Funds Index. It moves very, very slowly, bottoming out a few months ago. But it is rising at only about one-tenth percent per month. This is the only ARM index that is substantially below where it was one year ago.

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Cutting mortgage costs

The pros and cons of adjustable rate home loans

Wednesday, May 23, 2001

YOUR MONEY MATTERS By GEORGETTE JASEN Staff Reporter of THE WALL STREET JOURNAL Fixed-rate mortgages can look awfully tempting these days. After a decade of double-digit interest rates, it’s now possible to get a 30-year home loan for just over 9%. But don’t be too quick to lock yourself in. Over time studies indicate adjustable-rate mortgages are a better deal. "People are making bad decisions right now because they’re focused on the 1970’s when inflation and interest rates soared to record highs", says Christopher M. Condron, president of Boston Safe Deposit & Trust Co. "The premium you pay for a fixed-rate product isn’t worth it." The nationwide average for a 30-year fixed-rate mortgage at the end of last week was 9.24%, compared with 6.92% for the first year of a one-year-adjustable, according to HSH Associates, a Butler, NJ, mortgage information service. On a $100,000 mortgage, the difference translates into a $162 a month, or a savings of $1,944 the first year alone. "The variable rate is better to start with, and you have the prospect of it ultimately being  less expensive," says S. Timothy Kochis, a San Francisco financial planner. "You should borrow as much as you can for as long as you can and pump the savings into yield-generating investments", he says. The tradeoff is uncertainty. Adjustable-rate mortgages, which were created in response to the soaring rates of the late 1970s, carry a lower starting rate to compensate homeowners for assuming some of the risk of rising rates. Indeed homeowners who opted for variable rates in the spring of 1987, the last time rates were this low, saw their monthly payments jump several hundred dollars as interest rates rose over the next two years, before falling back to current low levels. Fixed-Rate Security "Most people tend to prefer the security of a fixed rate," says Warren Lasko, executive vice president of the Mortgage Bankers Association. "We all have enough stress in our lives without worrying about whether the mortgage payment is going to jump."  Only 10% of the mortgages written last month carried a variable rate, according to his organization’s figures, compared with half or more of 1988 and early 1989, when interest rates were rising. Still the savings with an adjustable rate can be enormous, especially for those buying more expensive homes. A recent study by Boston Safe Deposit, a unit of American Express Co., concluded that a homeowner who borrowed $1 million in 1984 (The company’s average mortgage is $875,000) would have saved a whopping $342,870 since then with an adjustable rate mortgage. The average length of a mortgage is seven years. Although the numbers are smaller, to the U.S. League of Savings Institutions, a trade group, reached similar conclusions about a $100,00 mortgage. According U.S. League calculations, the borrower who opted for a one year adjustable-rate mortgage in July 1984 would have saved about $7,000 over a fixed-rate loan – even assuming that the fixed-rate mortgage was refinanced in August 1986 when rates were just over 10%. Without the refinance, the cost of the fixed-rate loan would have been $32,000 more than the adjustable. A study by the U.S. League, covering the period between 1981 and 1990, found than an ARM would have cut a home buyer’s interest costs by an average of 25%. Much of that windfall, however, is the result of an overall decline in interest rates over the last decade, and some in the mortgage business urge caution. Betting on History "The studies presume that history will repeat itself, which we don’t know," says Arthur D. Ringwald, executive vice president of Sears Mortgage Corp, and unit of Sears, Roebuck & Co. Financial professionals say holders of adjustable-rate mortgages should keep track of interest-rate trends and be ready to refinance when rates start to turn upwards. For now, they say, that isn’t likely. The government’s report Friday on employment in August provided further evidence of the sluggishness of the U.S. economic recovery. While factory payrolls grew 42,000 last month, layoffs in other sectors reduced the net gain in non-farm employment to 34,000; the unemployment rate remained at 6.8%. Yields on both short and long-term Treasuries fell after the report, and some economists expect rates to fall further before they turn up. "There’s nothing in the current interest-rate horizon that suggests rates will rise," says Mr. Condron of Boston Safe Deposit. He says fully indexed ARMs could fall as low as 7% within the next year. Holders of adjustable–rate mortgages already have seen substantial drops this year, sometimes, as much as two percentage points, which means a significant reduction in monthly payments. Some rates are already as low as 8%.

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Remarks by Chairman Alan Greenspan

Understanding household debt obligations

At the Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C.
February 23, 2004

Mitigating Homeowner Payment Shocks
Rising debt service ratios are a concern if they reflect household financial stress and presage a drop in consumption or a rise in losses by lenders. Most homeowners and renters are aware of the possible difficulties should they lock themselves into a high level of debt payment obligations. Financial institutions might be able to help some households in this regard by looking for ways that households--both renters and homeowners--can shield themselves from unexpected payment shocks.

One way homeowners attempt to manage their payment risk is to use fixed-rate mortgages, which typically allow homeowners to prepay their debt when interest rates fall but do not involve an increase in payments when interest rates rise. Homeowners pay a lot of money for the right to refinance and for the insurance against increasing mortgage payments. Calculations by market analysts of the "option adjusted spread" on mortgages suggest that the cost of these benefits conferred by fixed-rate mortgages can range from 0.5 percent to 1.2 percent, raising homeowners' annual after-tax mortgage payments by several thousand dollars. Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.

American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.

Conclusion
In evaluating household debt burdens, one must remember that debt-to-income ratios have been rising for at least a half century. With household assets rising as well, the ratio of net worth to income is currently somewhat higher than its long-run average. So long as financial intermediation continues to expand, both household debt and assets are likely to rise faster than income. Without an examination of what is happening to both assets and liabilities, it is difficult to ascertain the true burden of debt service. Overall, the household sector seems to be in good shape, and much of the apparent increase in the household sector's debt ratios over the past decade reflects factors that do not suggest increasing household financial stress. And, in fact, during the past two years, debt service ratios have been stable.