At a time when money is tight, but local real estate prices are appealing, many property buyers are drawn to the lower interest rates offered by adjustable-rate mortgages.
But buyers beware. Like a jittery tech stock investment, mortgages with adjustable rates can be a risky venture.
In March, mortgage rates hit seven-month lows after hitting 45-year lows in the summer of 2003. The average rate on a 30-year fixed-rate mortgage declined to 5.58 percent, the 15-year mortgage fell to 4.87 percent, and the one-year adjustable rate dropped to 3.53 percent.
These low rates, coupled with a soft local real estate market, have many mortgage brokers in the Boulder Valley saying that now may be the best time to buy. But after two years of a sluggish economy, buyers may lack the spare dollars to snatch up the good deals.
That makes a 3.53 percent adjustable-rate mortgage look a lot better than the 5.58 or 4.87 percent fixed rates. A buyer can justify borrowing a little more money because he or she will pay less interest -- maybe.
The risk involved is that an adjustable-rate mortgage is exactly what it says it is -- adjustable. A fixed-rate mortgage stays locked in at one rate throughout the term of the loan, but an adjustable rate can move either higher or lower during the life of the loan.
Taking a chance
That 3.53 percent adjustable rate in the first year can, and most likely, will climb higher if the economy continues to improve. A history of adjustable-rate mortgages shows that these mortgages frequently change rates about one percent every year. In 2003, adjustable-rate mortgages hit a high of 3.99 percent, they reached 5.18 percent in 2002, 6.7 percent 2001 and 7.29 percent in 2000. Adjustable-rate mortgages reached a high of 8.59 percent during the 1990s and 12.2 percent in the 1980s.
Those fluctuations are the main reason a majority of property buyers go with fixed-rate mortgages. The fixed rates also change in the market, but once a buyer is locked in at a rate, the outside market changes do not affect their mortgage payments.
Yet adjustable-rate mortgages are still attractive to some buyers looking for a short-term mortgage or an investor with some financial savvy, said Ira Litke, a senior loan officer with Greenco Financial in Boulder.
"You'll always have a majority of customers going with the more conservative fixed rates, but in a region like Boulder with a well-educated and sophisticated population, adjustable-rate mortgages are more popular than in other parts of the country," Litke said.
Even though there is a risk of the interest rate going up, some buyers take the chance that they can beat those increases with the money saved from the lower adjustable rate interest payments. For example, if a buyer estimates he can save $20,000 on interest with an adjustable-rate mortgage, he can use the money to buy a bigger property or invest it elsewhere, like in the stock market. If the property or investments grow at a faster pace than the adjustable rates, the risk pays off.
Those who go with adjustable-rate mortgages also tend to have an optimistic view on their own financial situation improving, Litke said. An expected future pay raise, for example, might convince a buyer that he or she can bear the brunt of any possible higher future costs involved with an adjustable rate.
People who choose adjustable-rate mortgages also tend to believe that they will not need the loan very long, hoping that the rates will not increase too much in a short period of time, Litke said. With anything more than a five-year loan expectation, Litke said he frequently recommends his customers go with a fixed rate.
Like any mortgage, an adjustable rate isn't binding if the buyer wants to pay off the entire loan or refinance it to a fixed rate. However, Litke warned that the later refinancing to a fixed-rate mortgage could involve extra costs. Furthermore, if a person is getting out of an adjustable-rate mortgage because of raising rates, it is likely that the fixed rates also have increased.
GMAC Mortgage Loan Consultant Sharon Dillon said that if buyers go with an adjustable-rate mortgage, or any type mortgage for that matter, it is important for them to view the home or property as an investment. She said buyers should reinvest the saved money rather than spending it.
"If the extra money goes toward reducing the principal, at the end of a three-year adjustable-rate mortgage they've taken a nice chunk of that principal. When they go to refinance they can (borrow less money and) make lower payments," Dillon said.
For buyers who are willing to take even more risk to obtain lower payments, there is also a growing popular option that can be attached to an adjustable- or fixed-rate mortgage, Litke said.
The mortgage option is known as an interest-only loan, allowing the customer to pay only the interest on the loan for a period of up to 10 years. But again, to be effective, the saved money must go toward investments that beat the percentage of the interest on the loan. This is because without paying any of the principal, the amount of interest on the total payment will remain higher longer.
For some people, this isn't a concern, Litke said. "They don't worry about the principal not going down because the value of their investment is going up at a faster pace."
This makes an adjustable-rate mortgage with an interest-only option the most enticing option, but also the most risky one.
The Internet also offers a lot of appealing low mortgage rates, including adjustable-rate mortgages, but is less personal and also can involve many hidden costs. While there are some reliable Internet mortgage firms, many use what is known as a bait-and-switch technique -- meaning they advertise very low rates to pull customers in, but then inform the customers that they aren't qualified for the very low rate.
As with any large investment, Dillon said consumers should be patient in locating the right deal.
A mortgage loan also typically includes closing costs based on which mortgage broker a buyer chooses. Every lender has different fees and options on loans, and customers are advised to study every cost.
"There are hundreds of mortgage lenders and Realtors out there, especially along the Front Range," Dillon said. "Folks should do their research to find the right home, Realtor and mortgage lender."