Fixed-rate mortgages preferred by homebuyers
Mike Nixon
The Homeownership Alliance has confirmed that in addition to creating more opportunities for homeownership, historically low interest rates along with other economic factors have prompted more buyers to lock into fixed-rate products rather than adjustable or balloon plans.
"The fixed-rate mortgage is a cornerstone of the U.S. housing finance system and has been instrumental to the accrual of wealth on the part of many households," said Stuart Gabriel, Ph.D., director of the Lusk Center for Real Estate at the University of Southern California,color>, who wrote the Home Alliance report. "The low interest rates of the past two years have increasingly lured consumers seeking a predictable payment in an uncertain economy," he said.
Gabriel explained that fixed-rate mortgages were first introduced to the American public by the Federal Housing Administration during the Great Depression as a tool to increase homeownership. Before that time, balloon loans were common, requiring the borrower to repay a principle in its entirety by the end of 10 years. In turn, long-term payment plans were introduced to not only help make homes more affordable, but they also proved more profitable for lending institutions.
Because of the introduction of fixed-rate mortgages, homeownership in the United States between 1940 and 1966 grew from a level of 44 percent to 65 percent. During the late 1970s, when interest rates climbed as high as 21 percent, consumers looked for ways to reduce their home buying expenses. In 1981, adjustable rate mortgages were introduced, allowing lenders and borrowers greater product flexibility, but also creating greater financial risk for both.
A shakeup of the savings and loan industry in the late 1980s caused homeowners to take another look at how to protect their financial interests while seeking stability. The ARM began falling out of favor among borrowers during the 1990s, dropping from 39 percent of all mortgages in 1994 to only 12 percent in 2001.
By the first quarter of 2003, the common 30-year fixed-rate mortgage, on the other hand, accounted for more than two-thirds of the $7 trillion invested in the U.S. residential mortgage market.
"Clearly, borrowers benefit from the availability of [a] wider variety of products," Gabriel said. He explained that ARMS appeal more to mobile households, homebuyers who expect their incomes to be positively correlated with interest rate fluctuations and buyers who are downpayment constrained. ARMS also eliminate refinancing costs for the borrower during periods of declining interest rates.
By contrast, fixed-rate mortgages offer a sense of stability to the homeowner watching where household dollars are being spent. Kathy Alexander, outgoing president for the St. Louis chapter of the Mortgage Bankers Association, said that the Home Alliance report serves to confirm what lenders and borrowers have believed for a long time concerning lending preferences.
"It's always been a fixed-rate market here locally," she said. "The Midwest is considered to be very conservative, which is why we tend to gravitate to the fixed rate vs. the adjustable with the unknown."
Alexander agreed with Gabriel that in the current market the use of fixed-rate mortgages offer the best deal for borrowers and lenders. "It also helps with the economy," Alexander said, because, she explained, as house payments remain the same and incomes increase, consumers ultimately end up with more money to spend.