These questions came from some one who saw the interest rate chart in our "Yuba City Market Newsletter."

Question: Are adjustable rates always lower than fixed rates?

Answer: Yes, at least over the short term. As you can see from the chart below, adjustable rate loans are always less expensive than fixed rate loans.



Question: Why are adjustable rates lower than fixed rates?

Answer: The short answer is that there is less risk to lenders when they make loans with adjustable rate mortgages. Because there is less risk, they are willing to loan their money at lower interest rates.

The long answer goes something like this:

There are several factors lenders use in determining what interest rates they charge:

Their current cost of funds
The risk that their cost of funds will increase because of inflation
Their risk of loss (people with poor credit pay more than people with good credit)
Their cost to process loan payments, send out payment statements and coupons and otherwise service their loans

It was rising interest rates that caused the savings & loan industy's collapse in the late 1970's and early 1980's. When the prime interest rate soared to about 21% in 1979, the banks and savings & loans were paying out 15 - 16% on CD's. They were only collecting 7-8% on many of the loans they had made just a few years earlier. It was a real blood bath for them. The banks survived better because they had a smaller portion of their funds loaned out on long term, fixed rate mortgages.

Adjustable rate loans eliminate the bank's risk associated with an increasing cost of funds because they can pass that on to the borrower. In other words, the borrower is assuming the risk that interest rates will rise.

Question: How do I know if an adjsutable rate loan is right for me?

Answer: There is no definitive answer for this but here are some questions that may help you figure out what is best for you;

Is your income likely to increase in the coming years to help cover the payments if interest rates rise?
Can you afford the payments if you take out a fixed rate loan or do you need the lower rate to qualify?
How long do you think you are going to own this home?
How comfortable are you taking risks?

As for Tracy and I, we look at real estate as a long term investment and don't want to worry about a spike in interest rates causing us to be trapped in an investment with a negative cash flow. It's a little bit of the old adage about "eat well or sleep well."