- The Washington Times - Thursday, May 20, 2004

The mortgage-rate honeymoon might be over, at least for a while. The latest round of economic news clearly suggests that our economy is improving. This is certainly good news.

But with the good also comes the bad. An increasingly robust economy might be followed by inflation and higher interest rates.

Long-term interest rates have already taken an alarming spike.

Only two months ago, we were offering 30-year fixed-rate refinance programs with zero closing costs as low as 5.50 percent.

Today, the same zero-cost option is almost 1 percentage point higher. On a $300,000 loan, that results in almost a $200 increase per monthly payment.

So far, only the long-term mortgage rates, such as 30- and 15-year fixed programs, have risen considerably. Certain adjustable-rate programs that are tied to short-term interest rates have not experienced a significant spike.

When this happens, we have what’s called “widening of the yield curve.” This means that the spread between short-term rates, such as adjustable-rate mortgages, and long-term rates, such as fixed-rate mortgages, is increasing.

What does this mean for the future home buyer or refinancer? It means that ARMs start to look more attractive than fixed rates.

Let’s take my favorite ARM, the London Interbank Offering Rate, or LIBOR.

Last time I checked, the LIBOR index was still hovering around 1.10 percent. Add a 2 percent margin to the index, and we have a LIBOR ARM at only 3.10 percent.

When 30-year fixed rates were bouncing around in the low fives, a lot of folks were ignoring the LIBOR because they would happily pay a higher rate in order to eliminate any future interest-rate volatility.

No one knows for sure what’s going to happen with rates, but if fixed rates continue to rise at a quicker pace than some ARMs, demand for ARMs eventually will increase because they will be perceived as a better bargain.

In other words, consumers will be willing to absorb some interest-rate risk in exchange for a much lower rate.

It’s starting to happen now. With the LIBOR ARM around 3 percent and fixed rates pushing 6.50 percent, folks are realizing that even if short-term rates begin to rise, the significant and immediate savings are worth absorbing the risk of the ARM possibly exceeding 6.50 percent one day.

One thing that history has proved: Interest rates do not rise or fall forever. They are dynamic. When they rise, they will eventually fall, and when they fall, they will eventually rise again.

Deciding whether to take an ARM when the yield curve is wide depends upon the particular situation of the borrower. Payment affordability, anticipated holding period of the loan and personal risk-tolerance level are among the things a consumer needs to think about before making a decision.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).

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