Why are we even having this conversation? Banks are lending money for 30 years at 4 per cent. The last time rates were this low, the cool kids were groovin’ to Johnny Mercer and the Pied Pipers singing “Ac-Cent-Tchu-Ate the Positive.”
These rates are so low that if inflation were to surge, you could actually make money off a mortgage by investing the proceeds at a higher rate. Lock it in and don’t look back.
Adjustable rate mortgages, usually referred to as ARMs, do offer lower rates that you can lock in for certain periods, typically three, five or seven years, but you take the risk that rates could rise. After the locked-in term expires, the bank can rais the rate as much as two percentage points a year if interest rates have climbed. On a $250,000 mortgage, thats around $3,500 in the first year. Of course you’d refinance before the pain got worse, but you’d have lost the opportunity to borrow at four per cent.
Sure rates could go lower, but here’s a good rule of thumb for handling your money: Any time you see an extreme–in the late 90s stock valuations hit a 70-year high while oil prices hit a 50-year low–don’t risk your cash on the bet that the trend will continue.
The trend might continue for a while, but reversion to the mean is one of the few sure things in economics. (A decade later, the NASDAQ is trading at half its all-time high while a barrel of oil has shot up 1,000 per cent.)
When an ARM makes sense
OK, adjustable rate mortgages are absurdly low, too. If you are sure you’ll be selling your house in five or six years, a five-year adjustable rate mortgage at 3 per cent does make sense. But keep in mind I know a lot of folks whose “starter” home became the “rest of their lives” home. And does flipping a house in 5 years make sense?
This excerpt from “Worth It … Not Worth It?” was reprinted with permission from Business Plus/Grand Central Publishing.