Reading the Tea Leaves: ARMS vs Fixed

Just like in the stock market where too many people sell at the bottom and buy at the top, today more borrowers are choosing a fixed-rate mortgage over an adjustable rate mortgage (ARM) just as interest rates are easing up, says various sources as reported by Kathleen Pender in the Chronicle.

Sheryl King, a Merrill Lynch economist, notes that borrowers shift to fixed mortgages around the time that the Feds begin to cut interest rates.  Merrill economists forecast a weakening in the economy, which typically leads to the Fed reducing rates; the idea is that such a time is good to get an ARM because the trend in rates is down and thus the mortgage interest rate will adjust downward.

But some cry out for caution.  Greg McBride, senior financial analyst with Bankrate.com, says the reset rate on ARMs is determined by the one-year Treasury bill.  So, if rather than getting a fixed-rate now at 6.5%, you get an ARM with a first-year teaser at 6%, after year one when the first adjustment happens, the Treasury rate would need fall from 5 to 3.5% in order for the rate to drop to 6% — pretty unlikely.  He concludes that the value is in the fixed-rate.

Analysts do agree that you should not make a loan choice thinking that refinancing later will make it palatable, as there’s no guarantee that this can be done at terms favorable to you.

For those who can read tea leaves, consider the 3-1 hybrid ARM, something described best by Keith Gumbinger, VP of HSH associates in the Chronicle article.

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