Why It’s A Good Time To Look At Adjustable Rate Mortgages

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Mortgage rates are highly sensitive to expectations for the U.S. economy.

• When the economy is expected to sag, mortgage rates tend to fall
• When the economy is expected to surge, mortgage rates tend to rise

Currently, the economy is expected to sag and surge.  This is why adjustable-rate mortgage rates are holding their ground as fixed-rate mortgage rates increase.

Fixed-rate and adjustable-rate mortgages are not as interchangeable as in the past and it's mostly because the Federal Reserve's Fool in the Shower routine has created expectations runaway inflation later this year.

The "Fool in the Shower" bit goes like this:

• A fool gets in the shower and it's freezing cold
• To get warm, he flips the hot water on to full blast
• Before long, the water goes way past warm and into hot.  It burns him. 
• The fool turns the water back to cold and repeats the process in reverse.

The Federal Reserve is following the same pattern. 

The economy showed signs of weakness (i.e. being cold) last year so the Fed took steps to warm it up.  Since September 2007, the Federal Reserve has shaved 2.25% from the Fed Funds Rate. 

With each successive cut, though, the Fed is turning the proverbial water farther towards "hot".  This makes it more likely that the economy will go from "ice cold" to "scalding hot" sometime later this year.

Overheated means inflation comes back and now investors are taking notice. 

The growing likelihood of inflation is now priced into longer-term mortgage rates.  Inflation erodes the value of mortgage bonds so it's causing long-term mortgage rates to rise.

Meanwhile, short-term rates are still reflecting the short-term economic weakness to which the Fed is responding.  In the near-term, the absence of inflation is holding rates low for a host of products, including:

• The 1-year ARM
• The 3-year ARM
• The 5-year ARM

And that's where it ends.  There is a huge increase right at the 7-year marker.  The 7-year ARM along with the 10-year ARM and the fixed products are all priced for the Fool in the Shower bit, jacked higher for inflation and the eroded dollar.

Two months ago, the spread between a fixed-rate mortgage and a shorter-term adjustable-rate mortgage was .125%.  Today, the gap is 0.625%.