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I'm an economist, yet I only recently realized that adjustable-rate mortgages are economists' consensus best choice for consumers. Based on the expectation tha

by xapata 4y ago

I'm an economist, yet I only recently realized that adjustable-rate mortgages are economists' consensus best choice for consumers. Based on the expectation that personal economics are well-correlated with broad market economics, and that interest rates will decline when the economy struggles.

sokoloff 4y ago
I have a hard time squaring that with 15 year fixed rate mortgages being under 3% for several years in the very recent past and 30 year fixed mortgages being at/under 3% for part of that time. How would an adjustable rate mortgage be the best choice for consumers in that situation? I got an initial mortgage at 5.625%, refi’d to 3.875%, then again to some ~3% 15-year. I never seriously considered an ARM (and now wish I'd refi'd a third time back to a fresh 30-year fixed just to keep using that cheap money for longer).
- Ekaros 4y ago
  In past 10 year, variable rates commonly used in Europe have even been sub-0%. Meaning effective rate could have been under 1%.
- __derek__ 4y ago
  Most homebuyers don't hold their mortgage to term, whether due to selling or refinancing (like you). All things equal, an ARM will be priced lower than a longer-term FRM, so taking out the ARM with the intention to sell or refinance will mean lower guaranteed costs on the initial mortgage. They're basically a call option on rates during/after the initial fixed term. Even if rates go up a lot (like now), the pre-defined ratchet probably keeps them competitive relative to FRMs. Eventually, a weaker economy probably brings lower rates, especially combined with more equity and a shorter term. When 30-year FRM rates are 3%, though, take the fixed.
- deleted 4y ago
  [deleted]
kilgnad 4y ago
Why don't you get fixed rate so that the rate never goes up. When the background rate goes down you refinance for another lower fixed rate.
- sokoloff 4y ago
  It used to be the case that the adjustable rates were lower than the fixed rate. When a 30-year fixed was 8%, a 5/1 (5-year fixed, then adjusting every year) mortgage may have been 5% and a 10/1 may have been 6% for the fixed period. Once fixed rates got down to the 3-4% range, that seemed to no longer hold and I was frequently offered fixed-rate jumbo mortgages at rates slightly lower than adjustables (I have no idea why they even bothered to quote an adjustable at that point). If you could get a 10/1 cheaper than a fixed-30 and were pretty sure you'd be moving in 7 years, that's why someone would take out an ARM. (Or, if they could qualify for the ARM but not the fixed-rate payment.)
  - pc86 4y ago
    When have adjustable rates for the same property and money down been higher than fixed? They'd sell approximately zero adjusted rates if that ever happened.
    - sokoloff 4y ago
      Dec 2008-May 2009 and July 2020-Feb 2021 (for much of early pandemic, I was looking to refinance to lock in an even lower rate that I already had; I didn't manage to lock in the absolute low, but ended with ~3%) https://fred.stlouisfed.org/series/MORTGAGE30US https://fred.stlouisfed.org/series/MORTGAGE30US https://fred.stlouisfed.org/series/MORTGAGE5US https://fred.stlouisfed.org/series/MORTGAGE5US You do see a sharp reduction in ARM mortgages as a share of total with the interest rate reductions post 2008: https://i2.wp.com/financialsamurai.com/wp-content/uploads/2022/03/adjustable-loans.jpg?fit=1456,9999 https://i2.wp.com/financialsamurai.com/wp-content/uploads/20...
Godel_unicode 4y ago
That math is my favorite example of economists not living in the real world. It doesn’t account for the ability to refinance.
- xapata 4y ago
  It does, in fact. The bank prices that into the loan.
  - Godel_unicode 4y ago
    Huh? First, the bank can’t possibly price future interest rates into the price of a fixed loan as they’re by definition unknown. Second, we’re talking about the economic model of which is better for consumers. It assumes no refinancing to lower your interest rate down the road, which is a pretty big caveat.
    - xapata 4y ago
      > by definition unknown They're a known-unknown. Well-defined risk can be priced in. Black swans / unknown-unknowns can't.
      - Godel_unicode 4y ago
        Known in the sense that they know it’s possible, sure. Known in the sense that they know what the likelihood of any given rate increase is over 15-30 years (and are therefore capable of pricing it in)? No. “Priced in” has a very specific meaning, it’s not a generic term for being aware that something might happen.
        xapata 4y ago
        The derivatives market for hedging interest rate risk is fairly liquid. They can add the cost of an appropriate hedge (according to their risk appetite) into the price of the loan.

by xapata 4y ago

sokoloff 4y ago

I have a hard time squaring that with 15 year fixed rate mortgages being under 3% for several years in the very recent past and 30 year fixed mortgages being at/under 3% for part of that time. How would an adjustable rate mortgage be the best choice for consumers in that situation? I got an initial mortgage at 5.625%, refi’d to 3.875%, then again to some ~3% 15-year. I never seriously considered an ARM (and now wish I'd refi'd a third time back to a fresh 30-year fixed just to keep using that cheap money for longer).

Ekaros 4y ago
In past 10 year, variable rates commonly used in Europe have even been sub-0%. Meaning effective rate could have been under 1%.
__derek__ 4y ago
Most homebuyers don't hold their mortgage to term, whether due to selling or refinancing (like you). All things equal, an ARM will be priced lower than a longer-term FRM, so taking out the ARM with the intention to sell or refinance will mean lower guaranteed costs on the initial mortgage. They're basically a call option on rates during/after the initial fixed term. Even if rates go up a lot (like now), the pre-defined ratchet probably keeps them competitive relative to FRMs. Eventually, a weaker economy probably brings lower rates, especially combined with more equity and a shorter term. When 30-year FRM rates are 3%, though, take the fixed.
deleted 4y ago
[deleted]

kilgnad 4y ago

Why don't you get fixed rate so that the rate never goes up. When the background rate goes down you refinance for another lower fixed rate.

sokoloff 4y ago
It used to be the case that the adjustable rates were lower than the fixed rate. When a 30-year fixed was 8%, a 5/1 (5-year fixed, then adjusting every year) mortgage may have been 5% and a 10/1 may have been 6% for the fixed period. Once fixed rates got down to the 3-4% range, that seemed to no longer hold and I was frequently offered fixed-rate jumbo mortgages at rates slightly lower than adjustables (I have no idea why they even bothered to quote an adjustable at that point). If you could get a 10/1 cheaper than a fixed-30 and were pretty sure you'd be moving in 7 years, that's why someone would take out an ARM. (Or, if they could qualify for the ARM but not the fixed-rate payment.)
- pc86 4y ago
  When have adjustable rates for the same property and money down been higher than fixed? They'd sell approximately zero adjusted rates if that ever happened.
  - sokoloff 4y ago
    Dec 2008-May 2009 and July 2020-Feb 2021 (for much of early pandemic, I was looking to refinance to lock in an even lower rate that I already had; I didn't manage to lock in the absolute low, but ended with ~3%) https://fred.stlouisfed.org/series/MORTGAGE30US https://fred.stlouisfed.org/series/MORTGAGE30US https://fred.stlouisfed.org/series/MORTGAGE5US https://fred.stlouisfed.org/series/MORTGAGE5US You do see a sharp reduction in ARM mortgages as a share of total with the interest rate reductions post 2008: https://i2.wp.com/financialsamurai.com/wp-content/uploads/2022/03/adjustable-loans.jpg?fit=1456,9999 https://i2.wp.com/financialsamurai.com/wp-content/uploads/20...

Godel_unicode 4y ago

That math is my favorite example of economists not living in the real world. It doesn’t account for the ability to refinance.

xapata 4y ago
It does, in fact. The bank prices that into the loan.
- Godel_unicode 4y ago
  Huh? First, the bank can’t possibly price future interest rates into the price of a fixed loan as they’re by definition unknown. Second, we’re talking about the economic model of which is better for consumers. It assumes no refinancing to lower your interest rate down the road, which is a pretty big caveat.
  - xapata 4y ago
    > by definition unknown They're a known-unknown. Well-defined risk can be priced in. Black swans / unknown-unknowns can't.
    - Godel_unicode 4y ago
      Known in the sense that they know it’s possible, sure. Known in the sense that they know what the likelihood of any given rate increase is over 15-30 years (and are therefore capable of pricing it in)? No. “Priced in” has a very specific meaning, it’s not a generic term for being aware that something might happen.
      - xapata 4y ago
        The derivatives market for hedging interest rate risk is fairly liquid. They can add the cost of an appropriate hedge (according to their risk appetite) into the price of the loan.