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March 15, 1996
Mortgages failed to improve on the 8.125% level, and today are headed back toward 8.25%, driven by the strongest single-month rise in industrial production in eight years.
This report tends to validate last week's jobs report, and more than offsets news of low inflation. Home sales in January rose a surprising 4.2%, but the sharp rise in mortgage rates should soon squelch that sign of life.
When buying a house during a rising and unstable mortgage market, what's the best way to play defense?
The lowest risk strategy is to throw a dart at a 30-year rate, wherever it happens to be. You are completely protected from further rises, and it is so cheap to refinance these days that it's hard to be wrong on the downside by more than a percent or so.
One wrinkle to improve your odds, especially if you think you are buying during a temporary spike, is to pursue a low or no cost rate. If a "zero and zero" rate is good, better is to mark up the rate another .125% or .25% and get the banker to pay most or all of the closing costs.
A higher risk strategy is to pursue an ARM of some kind. Right now, the ARM approach doesn't work at all. You can get a one-year ARM at 6.50%, which is fine; but the loan will likely adjust to 8.50% in the second year, not so fine at all. For ARMs to work, T-bill to T-bond spreads need to widen. Right now, they are 5.40% / 6.74%, in contrast to 3.25% / 6.25% in the 1993 ARM glory days.
Hybrid ARMs are always worth a look, and often useful to bridge over a peak to the next refinancing opportunity. However, the same narrow, short-to-long spreads wipe out the hybrid advantages, for now. Today's 3/1 at 7.625%, 5/1 at 7.875%, and 7/1 at 8.125% aren't worth the trouble. (Exception: hybrids have no jumbo markup, and are useful versus today's 8.625% jumbo thirties.)
The absolutely, positively worst defensive play, and perhaps the worst loans invented since the negative-amortizing graduated payment (GPM, or "Gyp'em"), are the five and seven year balloons. If, at the end of the initial period, mortgage rates happen to be five percent or more above the start rate, your entire mortgage balance is due on the spot. Alternate mortgage usage for balloon is "bullet."
"Well, I'll just refinance." Great. To what rate? When? Any high spike will spook you into a refinance at a higher rate than you could have had in the first place. If you qualify at that inconvenient moment.
"Well, rates will never get to 11.50%." Usually heard from an X-er who thinks 8.00% is "high." For six straight years, 1979-1986, 30-year rates never fell under 11.00%. (If you would like a useful chart, ask any of the people below.)
Balloons are for rich people, sophisticated market watchers, or guaranteed transfers. For anybody else, they border on predatory salesmanship.
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