Ask the Credit Union Guy – fixed vs. adjustable rate mortgages

Meriwest Credit Union logoFixed vs. an Adjustable Home Mortgage Loan: What is best for you in the HEART/Meriwest Opening Doors homebuyer program?

By Greg Meyer – The Credit Union Guy, Meriwest Credit Union blog

Meriwest Credit Union and HEART have partnered for over 5 years now on the “Opening Doors” home loan program. We have helped over 30 families purchase homes in San Mateo County for as little as 5% down. Meriwest Mortgage supplies the first mortgage and HEART supplies up to $35,000 in a downpayment assistance second mortgage. A big question we get all the time is, “Should I take out a fixed or an adjustable interest rate mortgage?” Based on current interest rates and real estate prices in San Mateo County, here is our thoughts on this big question.

Home Loan Rates are at a historic low point. Fixed 30 year rates are hovering around 4.00% and could go lower if the real estate market stays slow for now. Interest rates are not effected by gravity so when they go down, they will not stay down. They will go up when the economy heats up. That could be by the end of 2012 or it could be a year or two away. The economic situation is very fluid right now.

This brings me to my point; rates don’t have very far to fall but they have a lot of headroom to rise. On a loan taken out today, an adjustable rate can go down a little bit over the near term, but those who have a new adjustable rate mortgage need to be conscious of the movements of the market and be prepared to refinance to a fixed rate loan quickly. The best bet is to grab a fixed rate mortgage now. At less than 4%, a borrower is borrowing at one of the lowest mortgage rates in recent U.S. history!

The Fed says that rates will remain low for a while. If there is a fix to the EU Debt Crises and our economy heats up, rates can go up fast. We have seen it repeatedly since 1978. Each time a recession has ended, lending rates went up quickly. Those with adjustable loans were hit the hardest as their loans are tied to the Fed rate, LIBOR, or the prime rate. Those rates can be very volatile in a heated economy. The Fed controls the money supply with interest rates. If the Fed governors feel there is too much easy money, they put the brakes on the economy and slow it down with a rate increase.

One last thing to keep in mind is a lender’s spread; the amount of interest he makes on money he lends vs. what he is paying for savings accounts. Typically, the spread should be about 2% or greater between the average interest rate being paid on savings vs. the average overall loan rate. Right now, financial institutions are paying less than 1% on savings accounts. There is room for rates to go down a little bit so that may make an adjustable loan more attractive. Many adjustable loans can go up 2% in one year. Thus, one can go from 3% to 5% on a mortgage loan in about a year. That would cause the payment to increase pretty dramatically. I think this is a good argument for a fixed rate loan.

Find out more about the HEART/Meriwest homebuyer assistance program here