Don’t Be Too Comfortable With Declining Rates

Adjustable rate mortgages seem like a particularly good idea when interest rates are declining. The lure of lower interest rates, low monthly payments, and the ability to afford a larger overall loan than would be possible with a fixed rate mortgage can make a powerful case in a consumer’s mind. This becomes even more true when interest rates are down or are declining.

Interest rates have remained low and trending downward for almost a decade. Many consumers might look at such a long history of low rates getting lower and conclude that there is little risk involved in securing an adjustable rate mortgage (ARM). There is some evidence that people are not considering ARMs to be all that risky, with the number of mortgages that are adjustable making up a substantial portion of the total mortgages (in the 20 percent range) at the end of 2003 and beginning of 2004.

However, economists believe that rates will begin to rise not just in the short-term, but as a long-term trend. This is due to a variety of factors. First of all, job growth, especially any major job growth, could contribute to rising rates. However, economists caution that even if the economy muddles along with little growth in jobs, big trade and budget deficits could cause concerns among foreign investors, causing them to demand higher interest rates. The Federal Reserve is also constantly trying to stimulate growth in the economy. While this type of growth may be a good thing overall, it could also lead to lots of interest rate increases.

This is why even with almost a decade’s worth of history of declining rates, the idea that such a trend will continue indefinitely is little more than wishful thinking. It also has the potential to be dangerous for consumers who get an ARM without first considering how they will pay for the increased payments if rates do indeed continue to rise.