As interest rates on mortgages begin to rise, some brokers and bankers are expecting demand for adjustable-rate mortgages to increase.
Part of it will be psychological, they say. Borrowers have gotten so used to hearing friends and family talk about getting a mortgage at 5 percent or 6 percent, that they may cringe at paying 7 percent or 8 percent, which historically is still a low interest rate.
If long-term, fixed mortgages head that high, adjustable-rate mortgages (called ARMs) in the 6 percent range may start looking like they are worth the gamble. Adjustable-rate mortgages can save you money upfront because they have lower interest rates. But there's the chance you could end up paying more later if rates rise, which analysts say is likely as the economy heats up.
"If they go into 7 or 8 percent, people will start asking about ARMs," said Diane Sadowski of Premium Mortgages in Amherst. "To them, that 1 or 2 percent really matters."
But borrowers in the Buffalo Niagara region tend to be a conservative lot when it comes to buying homes. Nationally, about two-thirds of the mortgages through HSBC Mortgage Corp. are adjustable rate, said Larry Schiavi, senior vice president of HSBC Mortgage Corp. But locally, they're only 20 percent.
"ARMs generally appeal to those borrowers who are living in markets that appreciate rapidly or have larger loan balances," he said. "It's a more sophisticated borrower. Generally, it's someone who doesn't expect to be in the house five years down the road. They're often professors or executives who relocate."
M&T Bank also sees more interest in adjustable-rate mortgages outside the Buffalo market, said Nick Buscaglia, administrative vice president of M&T Mortgage Corp.
"Western New York tends to be conservative," he said. "That conservatism causes them to be more interested in the safety and security of a fixed-rate loan."
A local bank recently offered a traditional 30-year mortgage for 6.07 percent. Yet, an adjustable-rate mortgage, where the rate is fixed for the first five years, is just 4.81 percent. On a $100,000 loan, that reduces the monthly payment by $80 and the total interest paid in the first five years by $6,300.
And you would have $1,500 more equity in your home than with a conventional mortgage.
Of course, there is a catch.
Let's say you stay in the house another two years and your mortgage rate increases 1 percentage point each year so it's now 6.81 percent. Your payment is now about $30 higher per month than someone who opted for the conventional fixed-rate mortgage, although you're still ahead when it comes to total interest paid.
Yet, if you stay in that house for the full 30 years of the mortgage and your rates increase a few more percentage points to nearly 10 percent, you will have paid nearly $50,000 more in interest than with a fixed rate.
Americans buy a new home, on average, every six years, according to the National Association of Realtors.
Roy Dean is betting that the time he spends in his new home in Royalton will be pretty average. He opted for a five-year ARM, which is saving him about $200 per month. Dean is perhaps a more sophisticated borrower than most, having bought and sold several rental properties over the years.
"It is kind of like gambling," said Dean, who owns Good Guys Automotive and Transmission in Niagara Falls. "Five years from now, I don't expect rates to be that much higher, and I will have paid more principal on the mortgage by taking the lower rates. And I don't know whether I'm going to be in the home permanently or not."
Most of Bill Markel's clients at the Amherst office of Merrill Lynch opt for adjustable-rate mortgages. Because that product is so popular throughout the company, Merrill Lynch Credit Corp. recently introduced a hybrid called a blended-rate mortgage. During an initial period of three, five or seven years, the mortgage is interest only and the rate changes at half the rate of an ARM. After that blended period, the mortgage acts like a traditional adjustable-rate mortgage.
"When they describe their situation, you try to get something that fits their needs," said Markel, a financial adviser. "You manage their assets and their liabilities. If a client says they're going to be in a place five or six years, why would you give them a 30-year fixed?"