I typically refer to the 30-year fixed mortgage as a set-it-and-forget-it type of mortgage because it’s fixed for the entire duration of the loan.
The mortgage rate in month one is the same as the rate in month 360. The mortgage payment never changes, though the total housing payment could vary thanks to things like taxes, insurance, and PMI.
Put simply, it’s a very easy mortgage to wrap your head around, and for that reason the most popular and common choice for homeowners here in the United States.
The same isn’t true elsewhere in the world, which is one of the reasons why the 30-year fixed has been questioned a lot lately by economists and mortgage pundits.
The latest opinion comes from Benjamin Keys of The Wharton School of the University of Pennsylvania, who analyzed how monetary policy makes its way into households via the mortgages borrowers hold.
During the most recent crisis, those with adjustable-rate mortgages actually “won” in a sense because their rates adjusted lower when the government stepped in and bought tons of mortgage-backed securities while lowering other borrowing rates.
Meanwhile, those with fixed rates didn’t benefit at all, and in fact were trapped in their mortgages because of equity issues, namely underwater mortgages.
This meant those who ostensibly took on more risk were rewarded when the wheels fell off. And those who were seemingly prudent in their mortgage choice were punished because they were unable to refinance until HARP came along.
Does that mean we should all go with ARMs instead of fixed-rate loans and hope the government takes care of the rest?
Is an ARM the Hands-Off Mortgage Solution?
Keys noted that there is an “automatic transmission of monetary policy through adjustable-rate mortgage contracts.”
In other words, the ARM adjusts with the greater economy and the borrower doesn’t have to go out and refinance or lift a finger.
Their lender will just adjust their payment as the index changes, whether it’s up or down. Of course, lately it’s been a one-sided argument, with ARMs generally falling at the reset, instead of climbing.
This has actually led to debt reduction and new spending, with borrowers who selected ARMs choosing to pay down higher-APR like credit cards while also purchasing new cars.
Effectively, the economy was stimulated via these ARMs because it freed up cash for households to inject back into the economy through other channels.
Mortgage defaults in this group also dropped by some 36% thanks to the reduced monthly payment.
To summarize, borrowers with ARMs didn’t need to do anything to obtain lower payments, despite the fact that most probably assumed they’d have to refinance out of the ARM once it adjusted (higher).
At the same time, their neighbors with fixed-rate mortgages set at 6% were probably shaking their heads, wondering how they wound up paying more.
Additionally, they had to keep a close eye on interest rates to ensure they weren’t paying too much, and then make the decision to refinance or not. That meant a lot of work (and worrying), ironically.
Interestingly, Wharton researchers found that regions of the country that had more ARMs recovered faster during the Great Recession, saw more auto sales, and increased local employment.
Could the Opposite Happen?
The problem is ARMs can move both up and down, and everyone (including Wharton) expects rates to go up the next time around.
The big question is how things will play out when that happens. Will the borrowers who elected to take out ARMs get burnt and require a bailout?
Will home prices go down more in the areas where ARMs were more popular?
If so, might the 30-year fixed prove to be the winner it was expected to be prior to the most recent housing crisis? And as such, should it be left alone?
All to be determined…but there’s a good takeaway here. Monetary policy can dictate whether ARMs adjust higher or lower, so in that sense the Fed has the ability to provide direct stimulus to homeowners, without tax rebates or mass refinancing programs. That’s a pretty powerful thing.
But if homeowners keep opting for the 30-year fixed, it’ll be difficult for the Fed to do a whole lot, and these homeowners might just find that their mortgages are a lot more work than they expected.