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It Isn't Too Late To Lock In Low Rates

By JANE J. KIM
From Dow Jones Newswires

July 14, 2004 -- Homeowners are facing some tough choices these days.

Anyone who's been shopping for a new loan has probably noticed that mortgage rates have been rising for months ahead of the latest rate hike by the Federal Reserve -- the first of what's expected to be a series of measured rate boosts.

But fence sitters who missed out on the chance to lock in record-low rates can still take advantage of strategies to keep costs down.

Lloyd Johnson turned to so-called hybrid adjustable-rate mortgages. Just last week, the 28-year-old sales manager from Atlanta replaced the 30-year fixed-rate mortgage on his home, which carried a 6.75% rate, with an ARM that will lock in a 5.5% rate for the first seven years -- shaving $650 off his monthly payments in the process.

"I also looked at how long I was going to be in the property," he said, noting that he expects he will have moved around the time the fixed-rate periods reset.

Faced with rising rates, a growing number of homeowners could turn to hybrid ARMs, which tend to have rates that are one to two percentage points lower than rates on conventional 30-year fixed-rate loans. Unlike traditional ARMS -- where rates can adjust more frequently -- hybrid ARMs typically carry a fixed rate for the first three, five, seven or 10 years then become an adjustable rate after that.

Most people already view hybrid ARMs as a fixed-rate product, said Doug Duncan, chief economist of the Mortgage Bankers Association. ARMs now represent about 35% of all home loans -- with most of that gain from hybrid ARMs, he said.

At Homestar Mortgage Services, where Johnson got his loan, refinancing of fixed-rate loans are quickly being replaced with ARMs. "What we're seeing now is a lot of movement to intermediate ARMS," said Rick Floyd, an executive vice president at the Paramus, N.J., mortgage lender. Refinancings as a portion of Homestar's total business has dropped back to more typical levels of 10% to 15% from a peak last summer of about 40%.

Still, it's not too late for some homeowners to refinance. Even though rates on 30-year fixed loans are up sharply from last year's lows, they are still low by historical standards. Rates on 30-year fixed-rate mortgages have climbed nearly a full percentage point from this spring's lows but have since eased to an average of 6.2%, according to HSH Associates, a Pompton Plains, N.J., financial publisher.

However, it's usually only worth refinancing if the interest rate you can lock in is at least one percentage point below your current rate in order to recoup the closing costs you'll have to pay. Rates are expected to end the year at 6.5% -- or 6.75% if inflationary indicators are strong -- and could average 7% in 2005, said Mortgage Bankers Association's Duncan.

Riskier Loans

Borrowers who have opted for short-term ARMs, where rates adjust more frequently, could be in for a shock. Since the lowest rates come with ARMs that adjust more frequently, they will start seeing their payments rise quickly as rates jump.

For that reason, if you can't afford a rise in your payments or are nervous about rising rates, you may want to opt for fixed-rate loans. It's also important to find out what caps are in place on the ARMs to find out how high the mortgage rates can climb, said Richard Musci, vice president at Charles Schwab Bank.

But even if the Fed hikes rates by 300 basis points, monthly payments on a 1-month LIBOR loan (an ARM that's tied to the London Interbank Offered Rate, or Libor, plus a margin) are still lower than payments on a 30-year fixed loan, said Larry Goldstone, president of Thornburg Mortgage Inc., a mortgage lender in Sante Fe, N.M.

To be sure, as rates and home values continue to rise, many borrowers will find it more difficult to afford their dream homes. That means that lenders are likely to push new financing options -- such as teaser rates and 100% financing -- to appeal to borrowers looking to minimize their monthly payments, experts said. "In mortgage lending, desperation breeds innovation," said Keith Gumbinger, a vice president at HSH Associates.

For example, lenders are increasingly pitching interest-only loans -- a payment feature that allows borrowers to pay interest and no principal in the early years of the loan. But such loans can be risky. Since borrowers aren't building any equity during that period, they could lose money if the value of their home falls. What's more, your monthly payments will be considerably higher after the end of the interest-only period when you'll have to start paying off the principal. That's why experts recommend interest-only loans to borrowers who plan on moving within a few years and are looking to maximize their cash flow and interest deductions.

It may also be worth asking for a shorter commitment period, especially since average closing times on loans have shortened. Lenders usually offer a "lock up" period for as long as 60 days at no charge, but if you think you'll be able to close the loan in less time, they might be able to reduce your rates. At Charles Schwab Bank, for example, customers can knock off 25 basis points on the discount points paid if they opt for a 30-day lock instead of the standard 60-day lock. Many lenders allow you to lock in rates for longer periods for a fee.

Those still worried about missing out on lower rates can, for a small fee, purchase a "floatdown" option which lets you lock in lower rates if they fall during your commitment period, said HSH's Gumbinger.

If the fixed rates on your ARMs are set to expire soon, you may want to refinance before rates head much higher. One option that could be cheaper than refinancing is a loan modification, which allows borrowers, for a fee, to change the terms of the loan, Thornburg's Goldstone suggested. In some cases, it may make sense to let your interest rate float -- especially if you took out a hybrid ARM with a higher rate over a longer fixed period, said Joe Rogers, national sales manager for Wells Fargo.

Homeowners should also start building a "subsidy" fund now, while rates are low, which can be tapped later when rates -- and monthly payments -- rise, HSH's Gumbinger suggested. Of course, whatever you can do to pay down your loan balances now will mean that the effect of higher rates will apply against a smaller balance.