Adjustable rate loans move out of picture for now

"We were going to do whatever got our payments down," said Mr. Askew, 25, a Dallas real estate analyst.

He was leaning toward the fixed-rate version.

"I was uncomfortable with an adjustable-rate mortgage just because of the risk involved," he said.

In the end, one clear-cut reason led the Askews to go with a fixed rate: It was worth their money.

And now is a great time to be locking in a rate on a fixed-rate loan, analysts said, because the rate "spread" – or the difference between fixed- and adjustable-rate mortgages – isn't wide enough to make taking on an ARM worthwhile.

"I'm a big ARM guy, but I'm putting people in fixed rates today," said Jim McMahan, division vice president and senior loan officer at CTX Mortgage in Dallas.

"It's becoming a fixed-rate market again."

As of Sept. 20, the average rate on a 30-year fixed-rate loan in Dallas was 7.87 percent, compared with 7.38 percent for the one-year ARM – an ARM whose rate is fixed the first year but may change annually thereafter.

The difference: just 0.49 percentage points, said Greg McBride, financial analyst at Bankrate.com in North Palm Beach, Fla., which follows consumer interest rates.

A year ago, the rate difference was 1.58 percentage points.

Narrow gap

"The current gap between fixed-rate mortgages and one-year adjustable-rate mortgages is the narrowest it has been since at least March 1983," said Keith Gumbinger, analyst at HSH Associates in Butler, N.J., which publishes mortgage information.

There are several reasons that's happening.

First, the Federal Reserve's rate hikes to ward off inflation and recent data indicating the economy may be slowing has led many bond market investors, who influence mortgage rates, to believe that Uncle Sam is winning the war against inflation.

"Almost all of the inflation premium which drove up fixed-rate mortgage prices has now been let out of the market," Mr. Gumbinger said.

Falling rates

Secondly, most mortgage rates are priced in relation to the 10-year U.S. Treasury note, whose yields have been falling.

"The benchmark for fixed mortgages, the 10-year Treasury, has seen yields decline 24 basis points [0.24 percentage points] over the preceding eight weeks, but the benchmarks for ARMS are mixed," Mr. McBride said.

The one-year Treasury is "virtually unchanged," but other measures used by lenders to govern ARMs continue to show increases each month, he said.

"Thus, the spread between fixed and adjustable rates continues to narrow," Mr. McBride said.

The bottom line: Rates on ARMs aren't low enough to make them worthwhile when you consider the risk, analysts said.

ARMS are essentially short-term fixed-rate mortgages.

The longer the fixed-rate period, the higher the interest you'll pay for that period.

At the end of the fixed period, the interest rate changes in accordance with the value of a specified economic indicator called an index.

"Adjustable-rate mortgages do not currently provide a rate low enough relative to fixed[-rate] mortgages that would compensate for the risk of higher rates in the future," Mr. McBride said.

That's the conclusion that the Askews reached.

"There's no benefit in doing an adjustable-rate mortgage," Mr. Askew said.

Time to move

Home buyers planning to remain in their new home a long time ought to lock in a fixed-rate loan now, analysts said.

"Interest rates probably don't have much more space to improve, especially given the fact that energy prices just continue to rise," Mr. Gumbinger said.

Another reason to lock in is that more companies are issuing bonds, and the increased supply is putting pressure on bond prices and interest rates.

"A lot of traders have been selling off longer-term Treasuries to make room in their portfolio for the upcoming corporate issues," Mr. McBride said.

Finally, there's a perception among bond investors that a new White House administration won't be as committed to paying down the federal debt as the Clinton administration was, Mr. McBride said.

The government's recent efforts to buy back Treasury securities and pay down the federal debt has helped push down long-term Treasury yields, some of which are used as benchmarks for mortgage rates.

"Bonds are having an ugly time, so if it continues, you'll start seeing some effects on mortgage rates," Mr. Gumbinger said.

So the message for mortgage fence sitters is: Jump off and decide on a mortgage rate.

"It's a real calculated gamble for someone who wants to wait it out a little bit longer [to lock in a fixed-rate mortgage]," Mr. McBride said.

"If you wait, you could lose because rates can go up, and the reality is, they're more likely to go up than they're likely to go down."

But determine how long you plan to stay in your home before deciding whether a fixed-rate mortgage truly suits your needs.

Matchmaking

You do that by matching up your time frame against the fixed period of your home loan and the costs of having the loan over that period.

For example, if you expect to be transferred a lot in your job, why pay for a long-term fixed-rate mortgage when you'll be moving in a few years?

"Anyone who will be in the home 10 years, they definitely should go with a fixed-rate mortgage," Mr. McBride said.

"But if it's shorter than 10 years, it should be adjustable. For the time horizon they will be in the home, it operates essentially as a fixed rate for them."

He said consumers buying their first home, with plans to trade up, should consider so-called "hybrid ARMs," which have a fixed interest rate for a period of years – commonly three, five, seven or 10 years – before they turn into a traditional one-year ARM for the remainder of the 30-year term.

"Take advantage of that lower fixed rate initially, with the idea that you will be out of the home by the time that rate becomes adjustable," Mr. McBride said.

You can take these additional steps to lower your mortgage payments:

Pay more points to lower your interest rate – A "point" equals 1 percent of a mortgage loan. If you can afford it, you may pay "discount points" to reduce the loan rate.

Make as big a down payment as you can.

Pamela Yip covers personal finance for The Dallas Morning News. If you have a story idea, e-mail her at pyip@dallasnews.com.