The Mortgage Reports Blog

Myth Busted: Relationship Between ARM and Fixed-Rate Mortgages

There are a lot of mortgage myths that Americans confuse for truth.  One of them is that adjustable-rate mortgages always carry lower rates than fixed-rate mortgages. 

As the chart shows us, that's false. 

But even when ARMs are lower than fixed-rate, that doesn't mean they're the better "low payment" option.

Two weeks ago, for example, choosing a fixed-rate mortgage over an adjustable-rate one made a lot of sense.  The interest rate spread was between the loan types was 1/8 percent.

For a few extra dollars each month, in other words, mortgage lenders guaranteed unchanging mortgage payments for the life of the loan.  This can be a relatively cheap insurance policy for homeowners.

Today, however, the market looks different. 

Since the Federal Reserve hinted its rate-cutting cycle may be over, the Fixed-ARM spread has widened to 0.500 percent, and the comparison is much different.  The "fixed-rate insurance policy" is much more expensive.

Mortgage markets change every single day so before locking your ARM or your fixed mortgage rate, check with your loan officer about how each is pricing out with Wall Street.

Don't have a loan officer?  Call this guy.  I have it on good authority that he knows what he's doing.

Why It's A Good Time To Look At Adjustable Rate Mortgages

Mortgage rates are highly sensitive to expectations for the U.S. economy.

• When the economy is expected to sag, mortgage rates tend to fall
• When the economy is expected to surge, mortgage rates tend to rise

Currently, the economy is expected to sag and surge.  This is why adjustable-rate mortgage rates are holding their ground as fixed-rate mortgage rates increase.

Fixed-rate and adjustable-rate mortgages are not as interchangeable as in the past and it's mostly because the Federal Reserve's Fool in the Shower routine has created expectations runaway inflation later this year.

The "Fool in the Shower" bit goes like this:

How The Flat Yield Curve Is Changing The Dynamics Of Choosing A Fixed- Or Adjustable-Rate Mortgage

The yield curve is brutally flat right now and a slight near-term inversion is stirring up recession talk in trader circles.

In the mortgage bond market, there is very little difference in mortgage rates between short-term ARMs (i.e. 3-year ARM, 5-year ARM), longer-term ARMs (i.e. 7-year ARM), and fixed-rate products (i.e. 30-year fixed-rate mortgage).

Just 0.375 percent separates them all and that's happening because of two competing economic outlooks:

• Near-term: There are concerns about inflation which is eroding the short-term value of mortgage bonds
• Long-term: A stable outlook is attracting investors to the long end of the curve

Meanwhile, with the Holiday Season Effect in full force, the public transit strike in Mahattan isn't helping market liquidity.  Loads of people (including traders) chose to stay home instead of go to work.

Mortgage rates could unwind quickly as a result.

Source
Union determined to stay on strike
Jennifer Smith
Newsday, December 21, 2005
http://www.newsday.com/news/local/newyork/nyc-twu1221,0,2389209.story

As Mortgage Rate Spreads Get Narrow, The Difference Between Choosing A Fixed Rate Versus An Adjustable Rate Mortgage Narrows, Too

Not since 2001 have mortgage rates spreads been as narrow as they are today.  The yield curve is starting to look more like a yield ledge.

As of today, rates on 30-year fixed rate mortgages are pricing just 0.375% higher than for a 3-Year ARM. 

That has tremendous significance to home buyers and homeowners alike.

For example, one question that helps to define an individual's mortgage planning strategy is: "How long do you plan to stay in this home?".  The more narrow the spread is, though, the less relevant this question becomes.

When the spread between a 30-year fixed and a 3-year ARM is as small as it is today, there is not much payment difference between the two (given an equivalent amortization schedule).

To put math on this:

• A $300,000, 3-year amortizing ARM carries a monthly cost of $1633.46
• A $300,000, 30-year amortizing FRM carries a monthly cost of $1703.37. 

For just $70 more per month, a homeowner can lock in a steady rate and a constant payment for the long haul.

But, because the 30-year fixed carries a higher mortgage rate, it also creates a larger tax benefit.  Assuming a 28% tax bracket, that added bonus is $26 monthly.  Therefore, the post-tax cost of choosing the 30-year fixed rate mortgage is $44.

If you liked it at $70, you have to love it at $44.