Since most American move every five to seven years, it’s a fair question to ask why most will opt for a 30-year fixed-rate mortage (FRM) these days.
Of course, we all know the answer: Rates are low and it’s nice to know that a homeowner’s monthly payment will never rise.
But let’s look at the matter from a different perspective, lenders’ point of view.
What’s in it for them to take the risk that interest rates will not increase beyond a profitable level? After all, they’re not in business to lose money. “In business” means just that, right?
Should the lender take the risk or the borrower? Borrowers willing to gamble undertake the risk by choosing an Adjustable Rate Mortgage, or ARM. The rates start lower than for FRNs, but they can scoot to undesirable heights during the course of the loan or when, and if, it converts to a fixed rate.
(I’m an ARM borrower hoping for, but not expecting, more historically low fixed rates when my loan switches in four or five years. At that point–and now, too, as a self-employed individual–refinancing will be out of the question.)
I was reminded of the conflict between whether borrower or lender should take the risk by a New York Times op-ed piece last week written by Bethany McLean. In it, she writes:
For a homeowner, a mortgage with a 30-year fixed rate (especially one that he can pay off early without a penalty) is a wonderful thing. For lenders and investors, however, it is a financial Frankenstein’s monster, an unnatural product filled with the potential for losses.
As all of us must know, however, it is not only the lender who assumes risk: It is the federal government (and you, dear taxpayer) through its support of Fannie Mae and Freddie Mac.
McLean’s thoughtful piece raises the notion of having financial institutions offer products they would rather keep than re-sell–for example, a 15-year mortgage that would adjust every five years. Such a loan would give the lenders at least some comfort and probably serve borrowers quite well.
No one has the slightest notion of where interest rates will be in 30 years. They don’t know where rates will end up even in five years. Hell, they can’t predict with any certainty what the level will be next year.
I recall that economists were pretty much agreed early in 2010 that they would approach 6 percent by the end of last year. They were off by approximately 1 percent–or 100 basis points, which I like for how big that sounds. Consider this: a 1 percentage-point error means that they were wrong by more than 16 percent.
While consumers who were able to lock in amazingly low borrowing costs have substantial reason to cheer their luck, the time may be nigh when we should take seriously McLean’s suggestion that the greater good for the housing market and thus the economy means not only thinking, but acting, out of the box.
Licensed Associate Real Estate Broker
Senior Vice President
Charles Rutenberg Realty
127 E. 56th Street
New York, NY 10022