Adjustable or Fixed?
For some time adjustable rate mortgages have gotten a bad rap. But are Americans paying too much for fixed rates? Alan Greenspan has said yes. According to the former federal reserve board chairman, many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade.*
Adjustable rates are consistently lower than fixed rates. The main reason for this is that with an adjustable rate, the bank exposes itself to less risk. Instead of committing to an investment where it makes a fixed rate of return for 30 years, it can more closely approximate a maximum rate of return for 30 years.
But adjustable rates aren’t just preferable for lenders, they also make more sense for consumers. Besides the obvious lower rates and therefore lower payments, adjustable rates also allow consumers to take advantage of falling interest rates without paying all of the closing costs for a refinance. And consumers with adjustable rates also avoid all of the headaches associated with refinancing-meeting with your loan officer, shopping your loan to make sure you are getting the lowest rate, providing tons of documentation, and taking time off of work to sign your loan documents.
The other big advantage of ARMs is that they offer more flexibility for less qualified borrowers. Not all borrowers fit the narrow “A” Paper profile. For example, self-employed borrowers don’t qualify for many programs. Even if you have owned your own business for years and have been very successful.
Of course, having an adjustable rate mortgage requires more vigilance than a fixed rate. But any wise borrower needs to manage his mortgage. This means fully understanding your ARM before you sign your loan documents. Make sure you understand how your loan works. What index is your loan based on? What is your margin? How high can the rate go? When does your loan readjust? This may require sitting with your loan officer or his manager several times until all of your questions are answered.
You will also want to carefully read every one of your loan documents at the time of signing. Most title agents want to sign you as quickly as possible but for transactions this big, it’s worth taking the time to read every word. For most people, their mortgage is their biggest financial obligation, and you want to make sure you get it right. And since new Adjustable rate loan products enter the market every month, you really have to do your homework.
*Simon, Ruth, “Is Greenspan Right About Your Mortgage?,” The Wall Street Journal, February 25, 2004, D1.
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