Q&A of the Day – What’s The Best Type of Mortgage Right Now?
Each day I feature a listener question sent by one of these methods.
Email: brianmudd@iheartmedia.com
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Today’s Entry: Brian, I wanted to get your thoughts on something. My son is looking at buying his first home (a condo) and is wondering what the best mortgage to go with is because of the high mortgage rates. I’ve always gone with a fixed rate mortgage but am wondering if it’s worth looking at an adjustable?
Bottom Line: My two cents on the subject is that looking at an adjustable-rate mortgage isn’t just a good idea currently...it may be the best idea for most who’re considering purchasing a property with a mortgage. However, there’s a lot more that’s worth considering before deciding on an adjustable-rate mortgage. On the surface an adjustable might seem sensible because mortgage rates are the highest that they’ve been in years and there’s an expectation that they’ll come down over time. Given recent history that seems logical enough. Taking a bit of a longer-term view at the history of mortgage rates paints a potentially different picture that makes the decision anything but a slam dunk. Let’s start by taking a look at mortgage rates historically and where we are today because it’s bound to surprise many.
What do you think the 50-year average mortgage rate is for a 30-year fixed rate mortgage? 5%? 6%? Even if you were to guess 7%, you’d still be low. The average 30-year fixed rate mortgage is 7.74%. What’s today’s rate? 7.7%. No kidding, while the news and the narrative has focused on what we now collectively call “high mortgage rates”, the average 30-year fixed rate mortgage is almost exactly the average historic mortgage rate. Consider that there wasn’t a full year in which the average mortgage rate was below 7% until 1998 and it didn’t become the norm until 2002. What we have as a society is a serious case of recency bias when it comes to mortgage rates. Starting with the onset of the Great Recession and continuing through the impact of the pandemic we’d experienced a historic 13-year period of exceptionally low interest rates that led to record low mortgage rates. In many ways that window of time was the inverse of what we experienced for 13-years from 1978 through 1990 – in which the average mortgage rate was never below 10% for a full year. Understanding this history and digesting the implications is extremely important before making assumptions about where rates might go from here.
For much of this year conventional wisdom from Wall Street to likely your street has held that the Federal Reserve would not only stop raising interest rates but would start cutting rates. That’s obviously been a losing strategy for those who’ve played it that way. Once again conventional wisdom has been anything but wise. To give you an idea of just how pervasive the wrongness on rates has been by the professionals who prognosticate these things... In March a CNBC Fed Survey of Wall Street professionals found that 86% thought the Federal Reserve would be cutting interest rates in the second half of the year. Not only hasn’t that happened – there are still questions about whether the Federal Reserve may raise rates even higher in their meeting next month. I’ve mentioned this for two reasons. First, for perspective, and second, because one could have done their due diligence on this topic, one may be well read on the topic and in the end the decision that’s made based on that info could be wrong. Also, if the experts have a hard time accurately projecting what rates are going to do over a matter of months, how likely are they or you to accurately project what they’ll be years down the line when an adjustable-rate mortgage starts to adjust to current market conditions? With that said, here are my thoughts on the situation.
Obviously, the purpose of a 30-year fixed rate mortgage is rate absurdity over a long period of time. That makes a 30-year mortgage great if rates are and not great if they’re not. One of the mistakes I’ve commonly heard of strategically, are buyers purchasing a home with a 30-year fixed rate mortgage with the idea in mind that rates will trend lower and when they do, they’ll refinance at a lower rate. That mindset really isn’t the most effective financially for two reasons that hit back at what’s asked about in today’s Q&A. It makes little sense to use a long-term fixed financial product to achieve a short-term outcome. If you lock into any longer duration fixed rate mortgage with that thought in mind, that rates will decline, and you’ll refinance, you’ll likely be paying a higher interest rate in the short term and you’ll potentially pay for additional closing costs unnecessarily longer-term, while having to guess at when to refinance along the way.
There are at least two reasons why an adjustable-rate mortgage makes the most sense for most people right now. Currently the average rate for a 5-year adjustable-rate mortgage is about 1.2% lower than for a 30-year fixed rate mortgage. That provides monthly savings of about $81 per 100k financed for a product that’s rate locked for up to 5 years if you’d want to hang onto it that long which takes me to the next point. The average length of time someone owns a home is eight years. That means there are an awful lot of people who are selling their homes within five years of buying it anyway. For anyone who isn’t buying their forever home that should be taken into account. Otherwise, for those who believe rates will trend lower over time, an ARM likely makes more sense because you can save money on lower rates today with the aim of refinancing at lower rates down the line anyway. But do be mindful about what I mentioned originally, rates are today, where they’ve averaged being historically. So, it may be the case that five years from now rates are close to where they are today. There are no guarantees.