Feb. 24, 2004 -- WASHINGTON -- Federal Reserve Chairman Alan Greenspan questioned whether American homeowners are making the most cost-effective choice in their preference for fixed-rate long-term mortgages.
"American homeowners clearly like the certainty of fixed mortgage payments," Mr. Greenspan noted in a speech to the Credit Union National Association here Monday. Fixed-rate mortgages protect against higher rates while offering the option of refinancing should rates drop. But homeowners pay several thousands of dollars a year for those benefits, he said.
With a typical fixed-rate loan, a homeowner protects himself from the risk that rates will rise sharply later by increasing his payment. A homeowner can, of course, refinance if loan rates drop sharply. But Mr. Greenspan said homeowners may pay 0.5 to 1.2 percentage points more than they otherwise would for those benefits. Fed staff estimate homeowners "might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade," Mr. Greenspan said, though not if interest rates had trended "sharply upward."
"American consumers might benefit if lenders provided greater mortgage-product alternatives to the traditional fixed-rate mortgage," Mr. Greenspan said. If homeowners are worried about a sudden jump in mortgage payments but are "willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."
Mr. Greenspan also reiterated that households appear to be in "good shape" and their rising debts relative to incomes don't reflect increased "financial stress." In fact, he said, their cost of servicing those debts has been relatively stable in the last two years thanks to falling interest rates. Unlike homeowners, however, he said renters' increased financial obligations for expenses such as rent, student loans and car payments, "may be of concern."
Increased bankruptcies "are not a reliable measure" of household financial health, he said, and delinquency rates are also flawed, though they paint a more encouraging picture, he said. Meanwhile, credit-card debt has increased in part because it is replacing unsecured personal loans and because they are used for an increasing variety of payments.
In last year's unprecedented refinancing boom, millions of homeowners took advantage of the lowest mortgage rates in a generation to lock in low 15- to 30-year fixed-rate mortgages. Those rates were often one to two percentage points higher than adjustable-rate loans, on which the rate is usually fixed for the first one to seven years, then adjusts up or down according to rates prevailing at the time of adjustment.
The Fed chairman didn't advise households to choose adjustable over fixed-rate mortgages. It is almost unheard of for an official of the central bank to offer advice on interest rates, over which it has enormous influence. But his remarks did represent a rare evaluation of the interest-rate choices that households face every day, and he implicitly questioned whether homeowners' preference for fixed-rate mortgages makes financial sense.
Whether an adjustable-rate mortgage makes sense now depends in part on whether the Fed keeps inflation, and thus interest rates, low, for the rest of the decade. However, adjustable-rate mortgages may make sense even if rates do eventually head up. Doug Duncan, chief economist at the Mortgage Bankers Association, said the share of mortgages carrying adjustable rates has more than doubled to about 25% recently in the last decade, as homeowners conclude they are unlikely to stay in their homes for 15 to 30 years. He said he knew of one lender that now offers 130 different mortgage products, up from about 15 a decade ago.
Mr. Greenspan noted that, in some other countries adjustable-rate mortgages are far more common and "efforts to introduce American-type fixed-rate mortgages generally have not been successful." That may be because homeowners in those countries feel the implicit fee for protection against rising rates and the right to refinance is too high, he said.