Fixed rates look better than ARMs

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Last week, I wrote about a radio segment that told the sorry tale of homeowners who hold adjustable rate mortgages (ARMs).

ARM holders are now facing ugly rate and payment increases as their mortgages are being reset. It seems that thousands of ARM holders across the country didn't become aware of the steady rise in rates, despite the consistent warnings by the Federal Reserve Board.

My guess is that there are plenty of ARM holders who chose to ignore these warnings and hold their ARMs because most adjustables were still well below 5 percent when the Fed began its series of rate hikes.

Even though fixed rates were below 6 percent at the time, ARM holders found it difficult to refinance a low ARM rate, despite every indication that they would soon be a lot higher.

But that's water under the bridge. Today, ARM holders are facing new rates in the 7 percent range and clearly feel as though they've missed the boat. While these folks may not have timed the mortgage market perfectly, the boat is still at port.

Although short-term rates have shot up considerably, long-term rates have increased at a much slower pace, keeping the door open for ARM holders to convert to a fixed rate that, by historical standards, is still pretty good.

The fact is that most ARMs are adjusting to rates higher than today's fixed rates. Let's take a look at some common ARM indices.

• ARMS tied to the LIBOR, or London Interbank Offering Rate were very much in favor from 2001 through 2004. The LIBOR tends to follow U.S. short-term rates and often will move more dramatically. This is why LIBOR-based ARMs were so popular. When the Fed was lowering rates, the LIBOR followed with enthusiasm, dropping more than most other ARM indices. Unfortunately, the LIBOR behaves in the same manner when it's on the rise -- moving higher than most other indices.

• The one-year Treasury Constant Maturity (TCM) is based on Treasury bills auctioned off by the federal government. This is a less-used index for ARMs but can be expected to move similarly to other short-term interest rates.

• The 12-Month Treasury Average (MTA) averages the yields on Treasury bills over a period of one year, making it slower moving and less volatile.