Are adjustable-rate mortgages dead?

July 12th, 2012

Adjustable-rate mortgages shouldered a great deal of the blame for the mortgage crisis, as ballooning monthly payments tripped up many home owners. The irony is that the last few years might have been an ideal time to have an adjustable-rate mortgage -- if it was the right kind of adjustable-rate mortgage. Looking forward, these loans aren't dead, but they may as well be in hibernation for a few years.

A bum rap?

The narrative surrounding the wave of foreclosures in recent years has often focused on supposedly unsuspecting home owners who were shocked when their mortgage payments suddenly skyrocketed. It's fair to ask whether these home owners share some of the blame for not looking at an amortization schedule before signing up for a loan.

At the very least, you might think they should know what the word "adjustable" means, or have the sense to realize when a deal seems too good to be true. However, whether you blame the borrowers, the lenders or some combination thereof, it is clear that certain types of adjustable mortgages were dangerous in the wrong hands.

This doesn't mean all adjustable mortgages are suspect. There are basically two kinds of adjustable mortgages -- those where the interest rate can vary periodically, and those where the structure of principal payment can vary as well.

The sharply-falling interest rate environment of the past few years would have been a good time to have the first type of adjustable-rate mortgage. Borrowers in those loans have likely seen their monthly payments shrink, not grow.

It is the type of loan with variable principal payment terms that can cause the biggest surprises. These loans should be limited to the most sophisticated borrowers.

A limited future

Simple adjustable-rate mortgages may have been a good deal in recent years, but their outlook now is more limited. Not only have mortgage rates dropped to record lows (meaning rates are more likely to rise than fall in the future), but the initial discount for an adjustable rate has shrunk.

In fact, given the low levels of rates today, anyone fortunate enough to have had the simple form of adjustable-rate mortgage in recent years might do well to consult a refinancing calculator to see if it makes sense to switch to a fixed-rate loan to lock in today's rates.

Posted By :

Richard Barrington has earned the CFA designation and is a 20-year veteran of the financial industry, including having previously served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc. Richard has written extensively on investment and personal finance topics.

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