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Should I take advantage of low adjustable mortgage rates?

Q: I was checking mortgage rates lately and noticed that ARM rates are now more than a full percentage point lower than 30-year fixed rates. With that much of a cushion, couldn't I just sign up for the adjustable-rate and refinance if rates rise by more than a point? Also, what are the odds that rates will rise by that much?

A: As mortgage rates have started to rise, 30-year rates have gone up faster than adjustable rates. This makes sense. If interest rates generally are headed higher, mortgage lenders should be particularly anxious to make sure they are not stuck with a sub-standard rate for 30 years, while adjustable rates will be able to re-set automatically.

Even with adjustable rates so much lower, there are two concerns I have about your plan of taking an adjustable rate now and refinancing only if rates rise by over 1 percent:

  1. You ask what the odds are that mortgage rates could rise by over 1 percent. Current mortgage rates are still extraordinarily low, and benefit from Federal Reserve intervention that will end eventually. In other words, rates seem very likely to rise at some point. As for how quickly this can happen, since 1971 there have been eight calendar years that have seen rates rise by more than 1 percent, so it can happen very quickly.
  2. Think about how confident you can be that you'll be able to refinance when the time comes. This is depends on your maintaining a good credit history as well as your home's ability to retain its value.

Adjustable-rate mortgages can be used to capture the lowest mortgage rates if you are planning on moving in a few years, because you can get out of the mortgage before the rate re-sets. Otherwise, you had better do some calculations to figure out how much rates could rise before your mortgage became unaffordable, and then decide if you want to take the risk of being able to refinance before that happens.

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