Mortgage Rates: You Have Many Options

Generally, the news media focuses on one number when reporting on mortgage rates: the Freddie Mac PMMS national 30-year fixed rate (which this week, happened to be 4.97%). This number is far from the whole story, however, and there are a handful of rates for other products and specific regions that I wish to expand upon below.

The first distinction is between 30-year and 15-year mortgages, which is significant both in form and in pricing. The average rate for a 15-year fixed is 4.33%, which is an incredible .64% higher than the equivalent 30-year rate. 15-year mortgages carry additional savings, since interest is accrued over a shorter time period. These savings are not insignificant and could easily total $100,000 or more over the life of a modestly-sized mortgage. On the other hand, the monthly payment associated with a 15-year mortgage will be higher, which means that your income ratio will also be higher, and the maximum size loan that you can obtain will be smaller.

The next distinction is between variable and fixed rate loans. Again, the disparity is not insignificant. While the full gamut of variable-rate mortgage products spans dozens, or even hundreds of different types, there are two that Freddie Mac monitors: Five/One-year variable rate and one-year variable rate. The 5/1 variable rate is actually a hybrid loan, and involves paying a fixed-rate for the first five years and a variable rate thereafter. The national average 5/1 variable rate is 4.11%, with an average margin of 2.75%, which is added on to a benchmark shot-term rate to determine the variable rate.

The average one-year adjustable rate mortgage rate is 4.27%, which is what you would pay not only for a variable-rate mortgage, but also what you could expect to pay after five years of having a 5/1 variable rate mortgage. In practice, many borrowers will refinance the mortgage within five years to avoid the uncertainty associated with variable rates. That’s because while short-term rates are currently low, they are projected to rise within the next 1-2 years, which would cause variable rates to rise proportionately. There is an inherent risk in any kind of variable rate mortgage, which is that you won’t be able to refinance if/when variable rates rise. The other risk is that fixed-rates could rise even faster, in which case it would have been more economical if you had taken out a fixed-rate mortgage in the first place. Of course, if variable rates remain low, then you may come out ahead. It is a gamble, and the decision depends largely on your comfort with risk/uncertainty.

The final distinction is regional, since mortgage rates vary across the country, sometimes by as much as .5%. Chances are, however, that this factor is beyond your control, as very few people would deliberately purchase a home in another part of the country merely because mortgage rates are lower! Besides, since mortgage rates are all derived from the prices for mortgage-backed securities – a national securities market – differences in rates are often offset by differences in points, so that the APR is ultimately the same.

Predicting mortgage rates going forward actually involves two separate predictions. Fixed rates are generally coordinated with long-term interest rates, and typically trade at a spread to Treasury Bond rates. Over the past 12 months, the Federal Reserve Bank has deliberately engineered a decline in fixed rates, through the purchase of $1.25 Trillion in mortgage-backed securities. These purchases, however, are slated to come to an end in April, at which point fixed rates could begin rising gradually, ending the year closer to 6%. If the Fed renews its purchases as some analysts expect, this would keep rates low, around the current 5% level. The Fed also has a role in determining variable rates, which are determined indirectly from the Federal Funds Rate. The Fed Funds rate has been set at .25% – a record low – for more than a year, and there is no consensus as to when the Fed will lift it. Futures prices indicate that a .25-5% hike before the end of 2010, but that is more of a guess at this point.

For the time being, then, both fixed and variable rates will probably remain low, though both could rise without warning at any time. Keep this in mind if you are considering a home purchase that would require a mortgage.