The statistics are different, depending on which group of lenders you talk to, but they all point in the same direction: Fixed-rate mortgages have made a strong comeback.
Only a year or so ago, adjustable-rate loans were the vogue, accounting for nearly a third of all loans, according to Federal Home Loan Bank Board figures.
Nowadays, however, fixed loans are back in style. More than half of today`s home buyers finance their purchases with fixed mortgages, says the bank board, which surveys all lenders.
The reason, of course, is simple: Mortgage rates are lower now than they`ve been since the decade began, and thousands more home buyers can qualify for a fixed-rate loan today.
Even though fixed loans are the high-priced spread on the menu of mortgage instruments, selling for as much as three percentage points higher than one-year adjustables, they are like old faithful. Their terms never change.
ARMs, on the other hand, allow the interest rate to rise and fall with market conditions. In other words, if rates go up, borrowers who opt for an adjustable will see their payments do the same.
Even though that makes for quite a bit of uncertainty, there are plenty of borrowers–48 percent, the bank board says–who are electing to take such a risk. But according to lenders, these folks aren`t the gamblers they appear to be.
With their set payment schedules, lenders explain, fixed mortgages are the first choice of conservative home buyers who like the idea of knowing exactly what they`ll have to pay, month in and month out.
There`s nothing wrong with that. In fact, lenders are the first to admit that a fixed-rate loan is the best option for some borrowers.
But because of the way ARMs are being structured today, with yearly and lifetime interest-rate and payment caps, adjustables aren`t as iffy as they once were, lenders point out.
Hence, ARMs shouldn`t be dismissed lightly as a worthy alternative only when rates or fixed loans are unaffordable.
To get an idea on how the lenders` thinking works, let`s dissect a $90,000, 30-year loan:
At 12 percent, for example, your monthly payment to principal and interest would be $926.10 for a fixed-rate loan.
Now take a one-year ARM with an initial rate of 9 percent, which is about right in today`s market. The payment to principal and interest would be $724.50.
For the first year, at least, the difference is $201.60 a month, or a total savings of $2,419.20 if you choose an ARM over a fixed-rate loan.
Next, let`s assume a worst-case scenario. Say the market rates go absolutely haywire, jumping skyward like a rocket.
With the fixed loan, your monthly payment would still be $926 and change. If your ARM has a 2-percent-a-year-interest-rate cap, as most do these days, your rate of the second year of the loan would rise to 11 percent, boosting your payment to $857.70.
Hence, even under the worst possible circumstances, your monthly payout with an ARM would still be less in the second year than it is for a fixed loan.
In year two, you`d pay $68.40 less a month with an ARM, for a total savings of $820.80. And for both years, the total savings would be $3,240.
Now let`s say rates continue to rise and your ARM rate jumps another two percentage points in year three. This would bring your rate to 13 percent and your monthly payment to $996.30, or $70.20 more than you`d be paying if you had a fixed loan.
In year three, then, you`d pay $842.40 more for an ARM. But you`d still be $2,397.60 ahead because of your savings during the first two years.
If rates continue to rise, your ARM payment would go higher still in the fourth year. But if your loan had a 5 percent, life-of-the-loan interest rate cap, another feature found in most ARMs today, your rate would go up only 1 percentage point more and never any higher.
Hence, in the fourth year, your rate would be 14 percent and your monthly payment would be $1,066.50. That`s $342 a month more than you`d be paying if you went for the fixed-rate loan.
Over a year`s time, you`d pay $4,104 more for an ARM, wiping out your savings in the first two years. But the difference after four full years is only $1,70640, and it wouldn`t be until the eighth month of the third year that you`d be on the negative side of the ledger.
Of course, if rates remained at or above this level, your ”loss” would mount–by $342 a month, or $4,104 a year for every year until you pay off your loan.
But lenders say there are other points to consider. One is that the ARM rates not only rise, they fall, too. So let`s reverse the scenario and allow the market rates to plummet.
If they fall two percentage points, your ARM rates drop back down to 12 percent, the same as the original rate on the fixed loan, you`d break even on your monthly payments, but you`d still be out $1,706.40.
But if they fell any further, your payments would be lower and you`d soon find yourself ahead again.
Obviously, no one can say for certain where market rates will be next year, let alone four years from now. So in that sense, ARMs are a crap shoot. Rates could go up and stay for several years, in which case the fixed-rate loan would be the best buy.
But they also could go up only slightly, or they might not go up at all. And there`s always the possibility that they could go down without ever going up.
