Fixed or Adjustable? A New Take on the Age-Old Question

by Tim Bruculere

If you think you’ve heard enough about interest rate risk lately, you’re probably not alone. Recent regulations require many credit unions to have a written policy on interest rate risk (IRR) management and a program to implement it effectively. The news is filled with stories about historically low rates on mortgages and deposits. The 30-year fixed-rate mortgage rate hit several all-time lows at the end of 2012.

So why would you consider an adjustable rate loan when it’s a virtual certainty that rates will eventually go up? As you can see from the following chart, which uses central bank data for the past six years and projects for the next 18 months, it’s hard to go below zero.

Let’s first consider the standpoint of the consumer. Since we are most familiar with mortgage rates, we will examine the factors that may help determine when an adjustable rate may make sense. Most consumers take a 30-year fixed-rate mortgage because the rate is historically low, and the lower payments make our budget more affordable. When purchasing a house, those low payments allow for a more expensive home. In addition, budgeting is easier because you know what your mortgage payment will be for 30 years.
Conversely, we have all read about “teaser” mortgages with low initial rates that adjusted far beyond the ability of the homeowner to pay the larger payments. This was a main cause in the economic crisis of 2008-2009 and the subsequent economic doldrums.

Adjustable Rate: Two Factors to Consider

Factor one: The average consumer mortgage is paid, either from the sale of the house or refinance, on the average of every five years. Factoring out refinancing, this number is around nine years. The number-one question the consumer should ask is: How long am I staying in the house?

continue reading »