Fixed-rate is the way to go

Right now, Nettie Brooks is shopping around Queens, looking to buy a two-family house priced anywhere from $400,000 to $600,000. Meanwhile, George Yacik is planning to purchase a two-bedroom condo in Stratford, Conn., priced in the high $200,000s.

What do these people have in common? They both plan to get a 30-year, fixed-rate mortgage. "Rates have already gone up and they'll be going up more," Brooks said. "I don't want to worry about my mortgage payments going up." Brooks' realtor, Elizabeth Gittens, owner of Gittens Quick Sale Realty in Queens, echoes Brooks' enthusiasm for 30-year, fixed-rate mortgages.

"Adjustable rates can go down in favor of the homeowner. But if they go up, a person on a fixed income could get into financial trouble trying to make higher payments," she said.

And more people are now sharing such views. After the heyday of low mortgage rates, which bottomed in the summer of 2003, the tide gradually began to change as the Fed raised interest rates 12 times since last summer.

Over time, short-term rates began to creep up closer to longer-term rates, which haven't risen as sharply. That made adjustable-rate mortgages (ARMs) riskier. And by mid-year, the appeal of ARMs had noticeably fallen from its peak popularity in March, according to data from the Mortgage Bankers Association (MBA).

Experts say rates were the big factor. As Yacik explained, "I found the differential between the 30-year, fixed-rate mortgage and various types of ARMs was not enough to be worth gambling on an adjustable rate."

Indeed, as he began searching for a mortgage in September, Yacik was surprised to find how close the rates on ARMs and fixed-rate mortgages had become.

According to the MBA, for the week ended Nov. 11, contract interest rates on 30-year, fixed-rate mortgages averaged 6.33%, versus 5.46% for one-year ARMs — producing a percentage difference of 0.87. By comparison, that rate gap was a noticeably wider at 1.6 percentage points in this year's first quarter, when ARMs were their most popular.

In terms of monthly payments, the cost for a $400,000, 30-year, fixed-rate mortgage stands at $2,484. That's just 9% higher than the $2,261 in monthly payments for an adjustable rate mortgage.

The gap narrowed from just a year ago, when adjustable-rate mortgages were 19% more expensive than their 30-year, fixed-rate cousin.

Through next year, the MBA expects the differential between long and short-term mortgage rates to remain at about the current level. The likely result: "We expect more borrowers will choose a fixed-rate mortgage," said Mike Fratantoni, the MBA's senior director in research.

But to Greg McBride, senior financial analyst at Bankrate.com, there is a better option: For the "average home buyer," he believes hybrid ARMs "are a better choice than the traditional 30-year, fixed-rate mortgage."

Hybrid ARMs are mortgages that have rates that are fixed for three, five, seven or 10 years before becoming adjustable. Ideally, borrowers would select the ARM hybrid that corresponds to the time they plan to hold a property. "Most borrowers move within a 10-year period," McBride said. If they take a hybrid ARM, they'll get an "initial rate that is always lower than on a 30-year, fixed-rate mortgage. And if their timetable (for unloading the property) pans out, they won't face the prospect of a change in rates" once the fixed-rate portion expires.

But beyond the fixed-rate period, rates in hybrid ARMs can change annually — which has become more worrisome lately. Those who obtained shorter-term hybrid ARMs earlier in the decade — when rates were extremely low — will see the fixed-portion of their mortgage expire in the foreseeable future, if it hasn't already.

If they allow their mortgage to become adjustable, they could get a jolt. For them, rate "increases are going to be pretty significant. Because of the change in interest rates since they got their mortgage, they could see their payments rise by several hundred dollars per month," said McBride.

For people in that plight, he suggests: "Run, don't walk to your lender to get a fixed-rate mortgage if you have an ARM that's due for repricing."

Handling higher rates

To help mortgage-shoppers cope in a rising interest rate environment, Keith Gumbinger, vice president at HSH Associates, offers these tips:

# Pay down your ARM. That way, you'll have a lower loan balance exposed to rising interest rates.

nReview the wide variety of loan products available. Some alternatives to a 30-year, fixed-rate mortgage might include an "Interest-only" payment plan or an "Option Arm," which gives borrowers several options of what to include in their monthly payments.

# Consider whether a "2-1" buy-down would be right for you. With this offering, you start with an interest rate that is about two percentage points below the market rate for the first year. Then rates start catching up. The final interest rate is usually about a half percentage point above current rates.

# Pay more fees or points to lower your mortgage interest rate.

# Take a shorter commitment period. That is the time between your application for a mortgage and when the loan closes.

# Offset the rise in rates with a bigger downpayment on the property.

# Look into getting a "second mortgage." If you can find attractive rates on home equity loans, consider using one of these to replace your current mortgage.

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.