Friday, March 2, 2012

Refinancing: fixed rate, or ???

A fixed rate alternative

With interest rates at historically low levels, many borrowers are finding value with a reliable fixed-rate mortgage.
However, as clients often turn to me and ask me what they should do, I point out that borrowers who think they will be moving/ selling in the not-too-distant future have another alternative: an adjustable-rate mortgage that offers several years at a fixed interest rate.

Hybrid adjustable-rate mortgages, or ARMs, originated in the jumbo-loan marketplace at the end of the 1980s. They fell out of favor – along with the riskier ARMs that offered extremely low teaser rates and interest-only components – after the subprime mortgage market collapsed.

Some adjustable-rate mortgages have an interest rate that changed every year, but a hybrid – also known as a delayed first-adjustment ARM – has a fixed interest rate for a period of time. Most loan officers refer to a hybrid by the period during which the rate is fixed. A 5/1 loan, for example, has a fixed rate for five years, then adjusts annually for the remainder of the term; a 7/1 loan adjusts after seven years.

ARMs account for only a small segment of the overall mortgage nowadays, financing just slightly more than 10 percent of home purchases. However, market share for hybrid loans is expected to increase to 14 percent this year, according to an annual survey released last month by Freddie Mac. The 5/1 hybrid was the most popular adjustable-rate loan product in the market, according to the survey. The least popular was a 3/3 ARM, which adjusts once every three years.

A common reason for choosing a hybrid ARM is projected length of homeownership. It’s a nice option for buyers who don’t expect to stay in their home for longer than three to five years.

Rates on hybrid ARMs are also attractive. As of last week, the average rate on a 5/1 loan was 2.81 percent, compared with 3.88 percent for a 30-year fixed-rate loan, according to Freddie Mac.

Borrowers should be aware though that with rates starting at rock-bottom levels, there’s generally only one direction for them to go. And even though there are caps on the rate change amount, the jump could be as much as six percentage points, when it adjusts.

Here is an interesting article from the New York Times on the subject.  Food for thoughts....


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