Borrowers' fears are rising faster than interest rates

By Diane Wedner

March 26, 2006 12 AM PT

Times Staff Writer

Climbing interest rates have spurred some worried borrowers to dump their short, fixed-period adjustable-rate mortgages for longer-term loans, but experts say fears of a rapidly changing market are overblown.

Borrowers who two or three years ago jumped into hybrid loans (those with low fixed rates for the first three or five years that then convert into adjustable mortgages), are now taking advantage of an infrequent phenomenon -- it’s happened eight times since 1966 -- in which long-term interest rates are lower than short-term ones, said Dan Weiss, a mortgage broker at Toluca Lake-based Golden State Lending Services. That’s making fixed-rate 30-year and hybrid 10-year, interest-only loans particularly attractive right now.

In February, 51.9% of all California home buyers used an adjustable-rate mortgage, compared with 63.7% in January and 68.7% in December, according to DataQuick Information Services, a La Jolla-based real estate research firm. The company attributes the drop to the narrowing spread between the cost of an ARM and a fixed-rate mortgage, and the popularity of home-equity loans, among other financial factors.

“A lot of people [with shorter-term mortgages] think they have to get out now or they’ll blow it,” said L.A.-based Legend Mortgage broker Mitch Ohlbaum. “They want prices locked in so they can put the loan to bed.”

Despite consumer fears, rates still are on the low end and are expected to remain there for at least the rest of the year, economists and brokers say. Rates on 30-year fixed mortgages averaged 6.32% last week, according to mortgage company Freddie Mac. On Tuesday, the Federal Reserve, which has boosted interest rates 14 times since June 2004, is expected to raise the rate that banks charge each other overnight. Since the Fed began raising rates nearly two years ago, long-term rates have not risen accordingly, as they historically have.

“People compare today’s rates to three years ago, when they were in the 5.5% range,” said David Soleymani, managing director of First Capital Mortgage in Santa Monica. “But these rates are still cheap.”

Nonetheless, jittery consumers are trading their short-term fixed-rate loans for the popular 10-year-fixed, interest-only loans, in which the rate is locked in for a decade and homeowners pay only interest, making it more affordable. For those who opt to also pay down the principal, the mortgage payment is recalculated each month.

In November, Tim Reynolds bought his Westside Village home -- north of Culver City and south of Westwood -- with a 10-year fixed-rate loan, locked in at 6%. The physician likes the fact that he can “ride the equity-increase wave” while making smaller, interest-only payments.

“My hope is that my home equity will increase and I can refinance in the future when alternative funding packages become available,” Reynolds said.

Meanwhile, homeowners who took advantage of the appreciation surge of the last half-decade and tapped into their home equity are facing the shock of line-of-credit interest rates that have nearly doubled to 7.5% since June 2004, when they were 4%. Lines of credit typically are interest-only loans whose rates are tied to the prime rate, the benchmark for many business loans.

Borrowers wanting out of these high-rate loans face difficult decisions, brokers say. The typical solution is to refinance the first mortgage, wrapping in the line of credit. But if homeowners have a low-interest, 30-year first mortgage, they are cautioned to think twice before refinancing that loan.

“I have clients with fixed-period adjustable first mortgages at 4.25%,” said Marc Shenkman, a Priority Financial Network broker in Calabasas. “I’m not going to have them replace a good mortgage with a bad mortgage just because they’re scared. Over the next couple of years, they’ll have an opportunity to refinance again.”

Borrowers who fear rising payments on their equity loans are discouraged by the fixed-rate, 30-year second-mortgage option, which is about 7.25%. Payments on second mortgages include interest and principal.

One of Weiss’ clients, who has a 5.5% fixed-rate $600,000 first mortgage and a $100,000 home-equity loan at 7.5%, recently called the broker seeking a way out of his rapidly rising line of credit. Rates today on jumbo loans -- those that exceed $417,000 -- are about 6.5%, so refinancing into one loan was discouraged by the broker. Converting his line of credit -- currently at 7.5% -- to a fixed-rate second mortgage at 7.25% -- didn’t appeal to the client either.

“Even a 10-year fixed with both loans was too expensive,” Weiss said. “If your first-mortgage rate is lower, there are no good alternatives.”

First-time buyers also face mortgage dilemmas. Those who barely qualify are choosing two- or three-year fixed-rate loans, with their less-expensive introductory rates. But they convert to much-higher-rate adjustables faster than the most popular loans today, said Pablo Martinez, a SmartEquity Home Loans broker in Pasadena.

“They just want to keep those [initial] payments low,” Martinez said. “They do whatever it takes.”

Would-be first-time buyers who are waiting for rates to come down before making a purchase should consider that by next year the rate could be 7.25%, experts say. On a $500,000 purchase with 20% down, the 6.125% mortgage today would be $400,000 and the buyer would pay $2,430 a month, including principal and interest. At 7.25%, the monthly amount jumps to $2,796, or $4,392 more per year.

Many economists predict that mortgage rates will tick upward to 6.75% or 7% by year’s end, which could presage a slowing of the mortgage and real estate markets, analysts say. Nonetheless, rates below 7% still should be considered good, brokers say.

“I tell people not to worry so much about the rates,” Calabasas broker Shenkman said. “If you can’t afford to pay for the house, sell it.”