They Gave Me A Band-Aid And Now I Need Stiches!

So, which is better, a Fixed Rate or an Adjustable Rate on your Mortgage? Why it's such an easy answer, both! Wait, no, that's not it. The real answer is neither. Nope, that's not it either. Ah-Ha, I have it, the answer is both & neither. Yep, that's it, that's the answer. Thanks for stopping by, my work here is done.

I'm kidding of course, there's so much more that goes into answering that question, client to client, case by case. I should mention though, if you aren't into the whole semantics of money, statistics, charts, & jargon of Economics, this may bore the heck out of you. In fact, I would recommend skipping the next couple of paragraphs because what will be said will be about as interesting to you as watching Professional Bowling Interviews after a bad hangover would be for me. That said, I advocate at least trying to learn something about the Yield Curve. It goes back to that knowledge is power thing, especially for you budding Money Junkies!

If you are a more financially savvy type of guy or gal, Real Estate Professional or Consumer, perhaps you're astute with the what is called the Yield Curve. To learn more about the what a Yield Curve is and how it works, check out this site.
If you are looking to purchase a home or refinance your current mortgage, here are my thoughts on the Yield Curve:

*Flat or inverted yield curve in a historically low interest rate environment = I Say Go FIXED*

*Flat or inverted yield curve in a historically high interest rate environment = A Tough Call. It REALLY depends on the individual's situation, but I dare say I would lean towards an Adjustable Rate to take advantage of riding rates down through the cycle.*

*Standard yield curve in a historically low interest rate environment = FIXED if a longer term purchase (10+ years), appropriate ARM if a shorter term purchase.*

*Standard yield curve in a historically high interest rate environment = Appropriate length ARM*

*In a standard yield curve, do NOT pay the premium for a 30 year protection when the vast majority of folks will not use the 30 year protection. Many won't need interest protection any longer than 10 years, hence the reason I like the 10/1.*

Home Equities = eliminating the open end vs. closed end mortgage situations = If Prime is very low I would recommend taking the rate that is fixed, if prime is very high, I recommend an adjustable rate - lock in the low rate when you can get it, use the ability of the ARM to move your payments down when you are at the top of the cycle.

OK, if you aren't dizzy by now, let's go a little bit simpler and look beyond the yield curve in determining rates.

A consumer's financial intelligence is rather critical in determining whether they should be put into an adjustable rate mortgage. A colleague of mine makes a good point, it's called The Sleep Principal. In other words, even if an ARM is the best option for you or your client, it is not the right option if they are going to lay awake at night worrying about the future rate of their mortgage. There's something to be said for having the least amount of worries in your life as possible. The roof over one's head is a terrible worry to have.

That said, what I really would like to concentrate is on all the 2/28 and 3/27 Adjustable Rate Mortgages and all the attention (some very negative) surrounding them. If you aren't familiar with what those products are, they are actually quite simple.

The 2/28 is a fixed rate for the first two years, after those two years, the rate then adjusts....Upwards.

The 3/27 works the same, only with 3 years of having a fixed rate.

Some called them Band-Aid loans, I'm not a huge fan of that term, especially if the customer needed stitches. Hence, the title to this post. A lot of what made these so popular is that those rates have been very near that to the best rates on the best market today and of yesterday. So, if you had credit bumps, bruises, bankruptcies, etc.....you may have been able to attain a rate on one of these programs in the 6% range for that 2 or 3 year time frame.
Then, things change, the rate adjusts and all of a sudden that rate changes and goes up, which means, your payment follows suit.

Let me point out the Good, The Bad, The Ugly, of these very products....in my own opinion.

The Good:

-It did give people a chance to re-group, get their credit back on the high road, and get further away from the credit bumps and bruises from the past. I've had numerous clients follow the plan & guidance I helped lay out and it took their scores from a 550 to over 700 when their rate was rate was about to adjust. It was in these instances that I could then put them in what would probably become their permanent financing, getting the best rates the market had to offer.

The Bad:

-Mortgage Professionals qualifying borrowers off the 2 or 3 year teaser rate to make sure their income qualifies for the loan. In my opinion, this was and is a bad idea all the way around. Anybody who is put into an adjustable rate product, should never be qualified off the floor rate. I'm not saying they should be qualified off the cap rate (or maximum % the rate can go up to) but I figure there has got to be a happy medium. How about qualifying them off the first rate adjustment?

The Ugly:

-This is the heart-breaker in my eyes. Take a family who was in a 2/28 or 3/27 and financed 95% to 100% of their home's worth at the time they went into that program. They did everything right, paid their bills on time, took care of any outstanding credit demons, and now their scores and credit file are in great shape! Except for one thing. They go to refinance and you find out they don't have enough equity to do anything at all. They're stuck and their rate is increasing and payment is following suit. Many areas have little appreciation, some as of late, none at all. Generally speaking, a client should not be put into these programs if they are financing more than 90% of their home's worth.

The bottom line is for the most part, there is no clear-cut answer to whether a fixed-rate is better than an adjustable or vice versa. It's a situation based answer. I will say though that the financially savvy people out there are the ones that can handle and benefit from adjustable rates the most. A large part of our population isn't financially savvy, especially about mortgages. Our high-schools and colleges need to address this. For the population who is in that boat, the fixed rate is probably the best way to sail.