As real estate prices have started to fall in many areas across the country, pundits are looking for people to blame. One target has been homeowners, who in some cases have stretched themselves to the limit to afford the houses they want. Using products such as interest-only and negative-amortization mortgage loans, borrowers have been able to get loans with payments they could afford. Yet these so-called "toxic mortgages" are often those most sensitive to interest rate movements, which are likely responsible for much of the rise in foreclosure activity during 2006.
However, it appears that many homeowners are starting to take action to protect themselves from interest-rate fluctuations. The latest release of mortgage statistics from the Mortgage Bankers Association shows that while refinancing transactions still account for nearly half of all mortgage activity, only about one in every five borrowers is using adjustable-rate mortgages to refinance. The share of the refinancing market attributable to adjustable-rate mortgages is at its lowest level since mid-2003.
Not the typical situation
The last time adjustable-rate mortgages were so unpopular, it was easy to understand the reason. Interest rates had just reached their bottom, and everyone was starting to look for the Federal Reserve to start to raise rates again. Because the ensuing rate increases would lead to higher mortgage costs when their mortgage rates were adjusted, borrowers started to shy away from them. At the same time, fixed mortgage rates were at multi-decade lows, so the added benefit of using an adjustable-rate mortgage was relatively low and didn't compensate borrowers for the risk of higher rates in the future.
Now, however, the situation is much different. Because the short-term rates on which adjustable-rate mortgages are based are currently higher than the long-term rates that longer-term fixed mortgages tend to track, many banks are offering borrowers better rates on fixed mortgages than on adjustable-rate mortgages. For instance, a quick check of rates at Washington Mutual
A fortunate exit for borrowers
For many borrowers, the current state of interest rates couldn't come at a better time. Facing adjustments in their mortgage rates that will increase their monthly payments substantially, some borrowers with adjustable-rate mortgages find themselves with an unusual opportunity to lock in lower monthly payments and interest rates by refinancing to a fixed mortgage.
Historically, borrowers who have gambled on future interest rates have often gotten burned. Typically, as short-term interest rates rise, long-term rates follow suit. As a result, it wouldn't be unusual for borrowers to face rates of 8% or higher for fixed mortgages following the hikes in interest rates over the past several years. With fixed mortgage rates hovering around 6%, however, those who chose to take the risk to get a lower initial interest rate won't end up paying the price for doing so. In fact, some borrowers would get a better rate by refinancing with a fixed mortgage now than they would have gotten even if they'd started out with a fixed mortgage several years ago.
Not for everyone
Unfortunately, the people who need the most help may not find it from refinancing to a fixed mortgage. For homeowners who truly couldn't afford anything other than interest-only monthly payments when they first got adjustable-rate financing, a fixed mortgage won't save them. The primary benefit of refinancing with a fixed mortgage now is not to save money on monthly payments but to stabilize payments at current levels without fear of further increases. If a given homeowner didn't qualify for a fixed mortgage in the past, it's unlikely that refinancing with a fixed mortgage now is an option.
However, the level of refinancing activity suggests that many people are qualifying for fixed mortgages, even with the increases in housing prices over the past decade. Although the data release doesn't break down the refinancing data according to the reason behind a borrower's decision to refinance, most of the other likely reasons for refinancing don't currently apply. Fixed mortgage rates have stayed relatively stable over the past few years, so there aren't many higher-rate mortgages left to refinance. Also, the downturn in housing prices has hampered the ability of homeowners to get cash back from refinancing. As a result, it appears likely that many borrowers are moving from adjustable-rate mortgages to fixed mortgages.
It's rare that people get a chance to make two profitable decisions in a row. However, that's exactly the opportunity that homeowners with adjustable-rate mortgages have now. Having saved a substantial amount of money in interest over the first several years of their mortgage, borrowers now can lock in the low rates that fixed mortgages currently offer. Given how unusual the interest rate situation has been in the last several months, homeowners should look closely at their mortgages to see if this is the right time to make a move.
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Fool contributor Dan Caplinger is trying to get his own mortgage finalized. He doesn't own shares of the companies mentioned in this article. Washington Mutual and Bank of America are Income Investor picks. The Fool's disclosure policy won't tap your equity.