But interest rates are so low!

Yes, I know.  But interest rates don’t matter. Stop chasing sexy interest rates while forsaking good financial decision-making.

I’ll also wager that the same familial financial advice-givers that told you to get the 30-year fixed-rate mortgage also told you not to spend money on depreciating assets, like a fancy car.  They say that it’s not financially prudent to throw a lot of money at something that you don’t have for very long and is ultimately disposable. (This particular piece of advice I agree with, by the way, but I will also concede that fancy cars are fun to drive and are a nice luxury item to purchase with disposable income.)

Please, please, please see the inconsistencies in these two positions. 

My clients who are in adjustable rate mortgages are saving a truckload of money right now, both in their mortgage balances, payments, and lack of refinancing fees.  Their interest rates are in the 3’s or lower.  For all of you who just read that sentence and are secretly and smugly thinking about how smart you are for getting a fixed-rate mortgage at 4.5% because interest rates are going up, I ask you these questions:  How do you know and when will it happen?  Those questions are important.

Look at this math:  The longer a rate is fixed, the higher the interest rate.  The longer the term of the mortgage, the more the bank makes.  A 30-year fixed-rate mortgage at 4.5% has an interest charge that is 82% of the original loan amount.  In the first five years, you pay 25% of the total interest charge.  In most cases, the loan balance isn’t cut in half until after year 20.  No kidding.  Here’s another fun math factoid of mine: A $500K loan, fixed at 3% has a payment of $2108.  In five years, the loan balance is $445K.  The same $500K loan, fixed at 6% has a payment of $2998.  In five years, the balance is $465K (yes, $20K higher after making $53K more in payments).

What does this mean?  If you’re going to take out a home loan for 10 years or less, the adjustable rate mortgage mostly likely puts you money ahead.  You’ll pay less overall and chip away at the principal faster such that in higher interest-rate years, you’ll be paying a higher interest rate but on a lower loan amount.  It still makes sense to take the adjustable, even in a low interest-rate environment. In fact, I would argue, especially so in a low interest-rate environment.

The 30-year fixed-rate loan is the Cadillac of mortgages—big, expensive, and probably disposed of in 10 years or less through sale or refinance.  If you won’t buy a fancy car, why are you buying a fancy mortgage?  I know, it is humbling to think about.  Your familial financial advice-givers mean well.  They do.  Sometimes they just don’t know what they don’t know.  Now you do.

But my mom told me to get one!

Of course she did.  Or your dad did or your grandmother, or whoever you take familial financial advice from.  They all told you to put 20% down on your house, get a 30-year fixed-rate mortgage, make extra payments, and get it paid off as soon as possible.  If I’ve heard it once, I’ve heard it a thousand times.  “I’m financially conservative,” my clients say, as if I’ve ever had a client come in and say the opposite.  No one—not one person!—has ever come into my office and said, “I like taking risk, let’s be risky.”

Here’s how I define financially conservative:  Managing one’s finances such that one has the ability to weather any financial storm or take advantage of a financial opportunity.  That means managing one’s cash and cash-flow to one’s best interests.

The 30-year fixed-rate mortgage is risky.  The risk?  That interest rates remain low. When you get an adjustable rate mortgage, you’re gambling that interest rates go down. When you get a fixed-rate mortgage, you’re gambling that interest rates are going up.  Gambling is gambling.  At times, your odds are better.  Right now, interest rates are historically low and the odds are on your side that rates will go up, maybe even considerably so.  But maybe they won’t.  I can’t tell how many years have gone by in which I’ve been saying that.  Probably since 2002.  I can’t tell you how many of my clients have refinanced at least once in that time period to get a lower rate.  And spending the money to do so.

Be conscious about what you’re doing.  The perceived “risk” that you’re really managing is unpredictability of payment.  For whatever reason, people love to know what their payments are going to be month-to-month.  If you’re going to be in your home less than 10 years, there might be a better way to manage that risk.  Imagine this:  You make your payment to the mortgage company and then “make a payment to yourself” by setting money aside into a cash account so that if in the future your payments go up (or you have to deal with another financial emergency or opportunity), you have the money available to meet that payment if you cannot do so out of income.  By doing so, you are money ahead and financially more secure.

Mortgage Rates and Products

My prediction is that rates will remain relatively low for 2010 and probably 2011. There will the usual ups-and-downs of mortgage rates, but historically speaking, rates will remain low.  A few pieces of advice:

1. If you can’t refinance your adjustable rate mortgage and its getting ready to reset, don’t panic.  Your rate may be adjusting lower or very close to what you have now.  You might want to keep that loan for a while.
2. If you have an equity line of credit that allows you to do a “fixed rate partition”—that is, fix the interest rate on all or a portion of the loan—consider doing this when you see the prime rate bump up a quarter to a half percent. Call your lender.
3. If you want the 30-year fixed-rate loan and haven’t gotten it, get it now. Give us a call.