Mortgage hunters go adjustable

When Earl Mason, a retiree in South Florida, went mortgage shopping in 1993, he went the way his wallet dictated.

"Interest rates were higher then, and the one-year, adjustable-rate suited my budget," Mason says. "I was able to buy the house I wanted."

So far, he's not second-guessing himself on the choice. "Although I am on a fixed income, I have never had a problem with the payments. Rates have gone up and down, but I figure I have averaged out a little less than a fixed-rate."

Another adjustable-rate borrower, Alan Roberts, of Palm Bay, Fla., has done equally well. "The biggest hassle is budgeting for the change in payments each year. But I think I paid a little less on average since I got this loan about six years ago."

With interest rates on fixed-rate mortgages averaging close to 8 percent in recent months, more people are finding that an adjustable-rate mortgage (ARM) fits the bill.

According to the Mortgage Bankers Association, ARM loan applications now account for 27 percent of all mortgages. In April, when interest rates were lower, that number was 10 percent.

"People have been surprised that housing has remained strong, but it is because consumers have moved into adjustable-rate loans," says David Berson, chief economist at Fannie Mae.

The attraction: The average rate for one-year ARMs hovers close to 6.25 percent.

ARMs make sense for home-buyers "when the spread between a fixed-rate mortgage and an adjustable-rate mortgage increases to the point that there are significant savings in payments," says Neil Bader, CEO of Skyscraper Mortgage in New York.

For example, if today's adjustable-mortgage rate is at 6.83 percent and a 30-year fixed-rate mortgage is at 7.90 percent, the savings would be about $70 per month for a $100,000 mortgage. This represents a 10 percent savings in monthly payments, which makes the difference worthwhile, totaling $840 in the first year.

Mr. Bader says that the most popular loan right now is the 7/1 adjustable. With this loan, the interest rate is fixed for seven years and then adjusts annually thereafter.

"It offers a significant discount from the 30-year fixed-rate. And since the average life of a mortgage is 6-1/2 to 7-1/2 years, this loan makes sense for most borrowers."

Mr. Berson suggests that the type of adjustable-rate loan a borrower selects should be based on that individual's tolerance for risk. That is, the ability to handle payment increases. Longer-term adjustables where the rate is fixed for the first five or seven years lower that risk.

If you are in the market for an adjustable-rate mortgage, here's what some experts say you should do:

*Find out if the loan rate adjusts monthly, semiannually, or annually. Some mortgages only adjust once during the entire life of the mortgage. Most ARMs, however, are adjusted annually after an initial fixed period of one, three, five, seven, or even ten years.

*Determine how high the interest rate can be raised. This is called a cap. Most common are mortgages with 2/6 caps for shorter terms and 2/5 for longer terms. The first number refers to the maximum percentage increase at each adjustment period. The second refers to the maximum interest rate increase during the lifetime of the loan.

*Ask exactly how your interest rate will be determined. There are two parts to each adjustment: the index and the margin. First, all interest rate adjustments start with an index.

The most common index is the one-year Treasury Bill Index that is an average of the previous four weeks' one-year Treasury bill rates.

The second part of the adjustment is the margin. This amount will be added to the index to compute your interest rate for the adjustment period. Margins can vary from 2 percent to 3.5 percent. A higher margin can mean a higher interest rate.

All lenders are required to give you an adjustable disclosure booklet describing adjustable-rate loans and how they work. Be sure to read this information before you apply for a mortgage.

Also ask for a disclosure on the type of mortgage you are considering. It will provide the details of what you can expect to happen when interest rates adjust.

Some adjustable-rate mortgages carry an option to convert to a fixed-rate mortgage at some future date. You might pay more for a conversion option, but, according to Berson, "There is no real advantage to a convertible mortgage because of the low cost of refinancing."

Bader agrees. "Conversion rates are very tricky," he says. "It is better to refinance when you can select the rate you want."

And one last piece of advice: Adjustable-rate mortgage loans can be very complicated because of all the variables. Do not accept verbal promises from the lender's agent without also getting it in writing.

If after reading the material provided to you, you still don't understand something, ask questions.

(c) Copyright 1999. The Christian Science Publishing Society

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