Money: The Rate Game

Long-term, fixed-rate mortgages have become increasingly affordable compared with adjustable-rate mortgages (ARMs) and home-equity lines of credit (HELOCs), and that spells opportunity for homeowners. Since June, the Federal Reserve has hiked short-term interest rates six times, and typically long-term rates follow. But the current pattern runs counter to that. "It's surprising," says analyst Greg McBride of bankrate.com The average rate for a 30-year fixed-rate mortgage is now 5.81%, according to HSH Associates, while the average one-year ARM is 4.32%. And the gap is narrowing. Even Fed Chairman Alan Greenspan termed it a "conundrum" in a recent report.

For borrowers nervous about struggling to make mortgage payments in a rising-rate environment, locking in a fixed rate seems like the right move. Says Chris Larsen, chairman of E-Loan: "We're seeing a migration to the longer-term, more conservative 30-year products."

Why this wrinkle in the usual order of things? Experts point to a variety of possible causes, including inconsistent job growth and steady purchases of U.S. dollar assets by foreign banks. But how long it will last is anyone's guess. Advises HSH's Keith Gumbinger: "[S]ince rates should have been heading higher already, it's important to factor that into your thinking." Here's how:

If you're in a short-term ARM or a new homebuyer, consider locking in a longer-term fixed rate for the period of time you plan to own your home. "Depending on your situation, that may mean a 30-year fixed or a seven-year ARM," says McBride. The difference between a five-year ARM and a 30-year mortgage was about 1.14% a year ago. "Now, it's about 0.25%," says Larsen.

If you have a home-equity line of credit with a payback period of 21/2 to 3 years or more, consider switching some or all of your balance to a fixed-rate home-equity loan. "The average rate for a HELOC last summer was 4.7%, and it's 5.8% now," says McBride. "It could be 7.5% 18 months from now." Locking in a rate of 6.5% now, on average, might make sense.

Don't rule out shorter ARMs, but be careful. Low "teaser" rates are enticing but might rise more quickly than they have in the past. Says Larsen: "Particularly if long-term rates end up lower than short-term, which could happen, the ARMs will adjust dramatically." •

Ellen McGirt is a senior writer at MONEY magazine