As Costs of Fixed- and Adjustable-Rate Mortgages Drift Closer, the Choice is Clear

According to the Roanoke Times, the number of borrowers who took on exotic loans in order to stretch to afford pricey homes has economists and housing analysts worried.

But with mortgage rates having fallen near their lowest levels of the year, many of those borrowers are jumping into the safety of a fixed-rate loan, says Richard Powers, general manager of Ditech.com, the online home loan provider, a unit of GMAC Residential Capital LLC.

These days, about two-thirds of borrowers who come to the mortgage company to refinance are opting to turn their adjustable-rate home loan into a fixed-rate mortgage, Powers said. The bulk of its home loan business, or about 80 percent, is comprised of mortgage refinancing activity.

“The main thing we see in terms of consumer preferences is the migration from adjustable-rate loans into fixed-rate loans. Low mortgage rates have largely driven that,” Powers said.

Meanwhile, the Mortgage Bankers Association reported that applications for mortgage refinancing were up 16 percent last week on top of a 25 percent jump the week before. Refinancing applications are now 60 percent above their year-ago levels.

The 30-year fixed-rate loan averaged 6.11 percent in the week ending December 7, according to Freddie Mac. Meanwhile, five-year hybrid adjustable-rate mortgages averaged 5.92 percent and one-year Treasury-indexed ARMs averaged 5.43 percent for the week.

For some, ARMs continue to make sense, Powers said.

“Some borrowers want the ability to manage that cash flow the way that an ARM can allow,” he said. “But most borrowers, they don’t want excitement in their mortgage payment. They want to be able to control that and eliminate as much volatility as possible. When they get this payment-change notice that says their payment’s going to go up hundreds of dollars a month, that’s usually the wake-up call. That’s why we’re seeing business benefit from borrowers who are getting into a payment that they know is secure and provides some known quantity down the road.”

The fact that adjustable- and fixed-rate loans are brushing so near to each other begs the question of why would a buyer want something that changes after five years when they could opt for a fixed-rate.

While borrowers may find better-than-average adjustable-rate mortgage deals in local markets, experts say, a fixed rate these days usually makes more sense.

On balance, the best product on the market right now is the 30-year fixed-rate mortgage because you get the stability with none of the risk, and it costs virtually the same as a product that does feature risk.

Still, there are plenty of borrowers holding home loans that promise some payment risk. A borrower who took out a typical 3/1 hybrid ARM three years ago is likely watching that rate jump to about 7 percent now as those loans reset. Many will be able to escape those loans and refinance out through a debt consolidation mortgage.

But not everyone will be so lucky - and the unlucky ones are likely to be concentrated among those who took out an option ARM, which allow people to make monthly payments so low they don’t cover the full interest charge. That unpaid interest gets tacked on to the loan principal, building an ever bigger pile of debt for the consumer, a dangerous thing if local housing values start to fall.

“Someone who took an option ARM and put very little money down and is in a marketplace where property values haven’t appreciated … those are people with increasing difficulties,” Powers said.

“They’re probably a small minority of the market,” he said. “A lot of borrowers are going to be able to refinance out … but there is going to be some fraction of the marketplace of unknown size at the moment that is going to turn around and mail the keys to the lender.”