The Rate Decision: Adjustable vs Fixed Rate Mortgages

Abstract

Homebuyers and commercial real estate buyers who borrow funds using mortgages all must face the choice of whether to assume a fixed or an adjustable rate mortgage. Other mortgage forms with alternative characteristics are available, but the deciding question remains the same. Fixed rate mortgages never change over time, but have a high initial rate: adjustable rate, interest-only or hybrid mortgages begin with lower rates, but they change at fixed intervals over time. In contrast to professionals, consumers are often ill-equipped to understand the benefits and drawbacks of mortgage instruments. With poor product knowledge they may find the choice between fixed and variable rate mortgages overwhelming. They need help in making informed decisions. Giving the bulk of consumers the knowledge that a university level finance course conveys is not possible. Thus, there is a need for a simple applicable technique that can improve financial choice. This paper offers a straightforward forecasting model, to make the decision easier and relatively risk free. Adjustable mortgages are not always the best choice, especially in a rising interest rate market or one that has a strong possibility of rising. The model is a decision making tool that may help ordinary consumers make the best choice. Alternatively, mortgage company personnel may use the forecast to aid consumers in selecting the best mortgage.