Long-Term Mortgages Are Getting More Expensive as Rates Rise

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Long-Term Mortgages Are Getting
More Expensive as Rates Rise

By Ruth Simon
From The Wall Street Journal Online

Borrowers looking for a good deal on mortgages are starting to run out of options.

For more than a year, rates on adjustable mortgages have been rising. But traditional fixed-rate mortgages have remained a remarkably good deal for borrowers -- and have also helped keep the mortgage and housing markets chugging.

Now that last holdout is no longer looking so compelling. The reason: While still relatively low by historical standards, the fixed rate on the average 30-year mortgage is about 6.5%, its highest level in more than two years, according to HSH Associates in Pompton Plains, N.J. Rates on one-year adjustables currently average 5.29%, the highest level since April 2002.

The increases are already having a broad impact. A growing number of borrowers are shunning the risk of adjustable mortgages and some are moving to lock in rates for longer periods.

Some lenders are targeting homeowners nervous about higher borrowing costs. J.P. Morgan Chase & Co. is adding interest-only options to many of its fixed-rate mortgages and hybrid adjustables. Interest-only loans allow borrowers to lower their payments in the early years. But borrowers can face sharply higher payments when the interest-only period ends, typically after five or 10 years.

A growing number of borrowers are opting for loans that provide them with predictability, instead of the lowest payment possible. At IndyMac Bancorp Inc., fixed-rate mortgages accounted for roughly 29% of loan volume in the third quarter, up from about 21% in the second quarter. And at U.S. Bank Home Mortgage, a unit of U.S. Bancorp, adjustable-rate loans account for about 25% of its mortgage volume, down from 33% a few weeks ago.

Rising rates have already begun to slow home sales, economists say. Applications for mortgages to buy homes have dropped below their level a year earlier for the first time in six months, according to the Mortgage Bankers Association, which expects home sales to fall 3.5% next year as rates on 30-year fixed-rate mortgages climb to 6.75% by the end of 2006. In a survey conducted last week, real-estate consulting firm Real Trends found that the number of home-purchase contracts signed last month dropped 8% from a year earlier at 48 large real-estate brokerage firms scattered around the country.

With rates likely to continue to move upward, borrowers who need a mortgage -- or have an ARM that is nearing its adjustment date -- are likely to be better off if they move quickly to take out a new mortgage. Even at today's higher levels, a 30-year fixed-rate mortgage is still relatively attractive. To shave a bit off their rate, borrowers should consider hybrid ARMs, some analysts suggest. Hybrid ARMs carry a fixed rate for as long as 10 years.

Rates also have risen on home-equity products. The average rate on a home-equity line has climbed to 7.32% from 4.68% in June 2004, just before the Federal Reserve began its campaign to raise rates, according to HSH Associates. Fixed-rate home-equity loans have risen more slowly, to 7.39% from 7.05%, in the period.

Homeowners are expected to pull a record $204 billion in cash out of their homes this year when they refinance, according to Freddie Mac. But Freddie Mac economists expect the amount of cash pulled out to fall to $114 billion in 2006.

The rise in rates is likely to prove painful for many borrowers with adjustable-rate mortgages. Rates will reset over the next 12 months on some $185 billion in adjustable-rate mortgages, estimates Bear Stearns, and $141 billion in mortgages will reset in the 12 months after that. When ARMs adjust, the rate typically resets to the prevailing market rate, though generally there are limits on how far rates can rise.

Stronger-than-expected economic performance and increased worries about inflation have in recent weeks boosted the yield on the 10-year Treasury note, which serves as a benchmark for long-term mortgage rates. It's now a bit below the 16-month high of 4.67% it reached on Nov. 4, but many analysts expect the trend to be upward as the Federal Reserve raises short-term interest rates to keep inflation in check.

At Thornburg Mortgage Inc., which specializes in jumbo loans, nearly three-quarters of borrowers are choosing hybrid ARMs that carry a fixed rate for the first seven or 10 years. A year ago, just 5% or 10% of borrowers took out such loans, the company says.

Wells Fargo & Co. two months ago began contacting borrowers with adjustable-rate mortgages in an effort to draw attention to what could happen to their monthly payments when rates adjust and to see if they want to refinance. The bank also is promoting its "Flex/Fixed" mortgage, which allows borrowers to buy down the rate in the first year or two by agreeing to pay a somewhat higher rate for the remaining term of their mortgage.

For some borrowers, a buy-down option can make sense because it gives them a lower rate today in exchange for a higher rate tomorrow. But whether it's a good deal depends on a number of factors, including how long the borrower stays put, what happens to rates and the relative cost over time of other alternatives. For instance, a borrower who plans to stay put for a number of years could wind up paying more in interest over time with a buy-down option.

Borrowers who expect to move in the next five or 10 years might consider a hybrid ARM that is fixed for the first five, seven or 10 years, says Greg McBride, a senior financial analyst at Bankrate.com. Loans that adjust more frequently make sense only for a small group of borrowers who expect their incomes to grow faster than their mortgage payments in the next few years, he adds.

But the benefits of a hybrid ARM have decreased as short-term market interest rates have moved closer to long-term rates over the past year. This also narrows the gap between short-term and long-term mortgages. Rates on hybrid ARMs that are fixed for the first 10 years average just 0.16 percentage point less than rates on 30-year fixed-rate loans, according to HSH, below the typical 0.20-percentage-point gap. The gap between fixed-rate mortgages and ARMs fixed for five years is just 0.46 percentage point. Typically, borrowers can cut their rate by 0.70 percentage point by opting for a "five-one" hybrid.

Homeowners who had grown accustomed to pulling cash out of their homes by refinancing their mortgages may be better off taking out a home-equity loan or line of credit, particularly if they have a fixed-rate mortgage. That's because their new mortgage is likely to be more expensive than their old one. A borrower with a $300,000, 30-year mortgage, for instance, would pay an extra $142 a month if the rate on their loan jumps to nearly 6.5% today from 5.75%, which was the average rate in June. That's before the extra interest costs associated with a higher loan balance.

Email your comments to ruth.simon@wsj.com.

-- November 17, 2005