Adjustable Rate Mortgages - Like Playing Financial Russian Roulette

During the past two decades, borrowers have enjoyed a general environment of declining interest rates. This has been a blessing for borrowers, while it has been a curse to a certain group of people such as retirees living on interest income.

Back in the early 1980's, mortgage interest rates were at record levels in excess of 18%. However, with each passing year, the country saw a gradual decline in interest rates, albeit there were a few hiccups along the way. By 2004, interest rates on home mortgages had declined to 40-year lows, bottoming out at slightly over 5% for a 30-year, fixed-rate home mortgage.

To take advantage of lower interest rates and thus lower monthly payments, many people went through the mortgage refinancing process during that time. Because of a two decade long recent tradition of falling interest rates, most people have grown accustomed to lower or falling interest rates. This is especially true for those 40 years of age and younger. Their entire adult life has seen a falling interest rate environment. During this period, mortgage refinancing to take advantage of lower rates became almost a habit. And why not? It certainly made financial sense to do so.

In the most recent decade, because of the established trend of falling interest rates, many people who refinanced their homes opted for an adjustable rate mortgage. This gave them the best of both worlds: they received an initial lower rate compared to a fixed-rate loan at the time, and, in a falling interest rate environment, the interest rate on their mortgage kept going down with each passing year.

The problem is that trends in motion remain in motion until they change. And the trend of falling interest rates has now reversed.

There have been many studies done on interest rates, by many great minds in mathematics and economics. No two studies reach identical conclusions. That's not surprising. But rather than argue over minor differences in conclusions, one should step back and look at the big picture: studies do show that there clearly is a cycle in interest rates.

The major cycle seems to indicate that the overall major trend interest rates lasts approximately 22 years. While hindsight is always 20/20, and foresight is usually blurry at best, it seems that the 22 year period of falling interest rates is now completely behind us. If history is any guide, we now have a 22 year period of rising interest rates ahead of us.

Borrowers who refinanced with adjustable rate mortgages in recent years will now find out that an ARM is a double-edged sword. The benefits of an ARM were great when interest rates were falling, but the drawbacks of an ARM will become all too clear in an environment of rising interest rates. Those people who have an adjustable rate mortgage will feel the pain of rising interest rates.

The best way to avoid that financial pain is to refinance your mortgage now and lock in a fixed interest rate while they are still only slightly higher than historic lows.

The major trend in interest rates has clearly turned. It is not apparent to many people yet, but to those keen enough to study history and pay close attention to detail, all of the indications are there. Now is the time to get out of adjustable rate mortgages and into fixed rate ones. Keeping an ARM in this environment is like playing Financial Russian Roulette - it may not be today, but some day soon the bullet of rising interest rates will find its way into the chamber and inflict its financial pain on you.

 

 

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