By RUTH SIMON and RACHEL EMMA SILVERMAN
Staff Reporters of The Wall Street Journal

From The Wall Street Journal Online

This week, no less an authority than Federal Reserve Board Chairman Alan Greenspan suggested that many Americans do. In a speech to credit unions, Mr. Greenspan said that Federal Reserve Board research showed that "many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade" as rates tumbled.

Yet the more expensive fixed-rate loans accounted for 81% of mortgage originations last year, according to the Mortgage Bankers Association. That's because most borrowers are risk-averse and fixed-rate mortgages protect them from the possibility that interest rates will rise over the life of the loan.

The problem is that as home prices soar, choosing a long-term loan is an increasingly costly decision. In the current market, borrowers can cut the rate on their mortgage drastically by opting for an adjustable-rate mortgage instead of a 30-year fixed-rate loan. Currently, rates average 5.71% on 30-year fixed-rate mortgages while they average just 4.53% on mortgages that carry the same rate for the first five years and then adjust yearly, according to HSH Associates, a financial publisher.

Lenders are increasingly pushing ARMs because they allow buyers to either trim their payments or buy more home for the same payment. ING Direct, an online bank, decided to offer only adjustable-rate loans when it entered the mortgage market last year. "We don't do any fixed-rate mortgages," says ING Chief Executive Arkadi Kuhlmann. "We believe that it's a pretty expensive option for consumers."

At Washington Mutual Inc., ARMs accounted for 55% of home loan applications in the fourth quarter. At a time of rising home prices, the lower start rates on ARMs allow borrowers "to maximize their buying power," says Greg Sayegh, Washington Mutual senior vice president.

Still, it's not clear if Mr. Greenspan's comments were well-timed for most people shopping for a mortgage. A bet on an ARM is a bet that the extremely low interest-rate environment of recent years will continue. The adjustable-rate mortgages have been a great deal in the past four years as the rate on an ARM that adjusts yearly tumbled to 3.71% from 6.81%. Those with ARMs saw their payments drop automatically. Whereas those with fixed-rate mortgages had to lay out thousands of dollars in refinancing costs to capture the savings from lower rates.

Whether ARMs remain golden in the future depends on which direction interest rates go. If rates begin climbing shortly -- as many economists forecast -- not locking in a rate with a fixed-rate mortgage could be a big mistake. The rate on a 30-year fixed-rate mortgage could rise to roughly 7.5% by the end of next year, estimates Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley. (Fed watchers, by the way, don't see Mr. Greenspan's remarks as a signal by the chairman on the future direction of interest rates.)

Homeowners have certainly been stung by rising rates in the past. A borrower who opted for a one-year ARM in July 1996, for instance, could have secured a rate of 6.11%, well below the 8.36% rate on comparable 30-year mortgages, according to HSH. A year later, however, when rates rose, the rate on the ARM climbed to 8.61%.

For that reason, borrowers who can't afford a rise in their house payment should probably opt for fixed-rate mortgages. And the lowest rates come with ARMs that adjust as frequently as once a month. That means if interest rates begin rising, your payment will quickly climb.

A key factor in selecting a loan is how long a buyer plans to live in the house. Opting for an ARM is a no-brainer if you plan on moving in a few years. If you want the best of both worlds, think about a hybrid ARM where the rate on the mortgage is locked for about as long as you expect to remain in the home. The typical hybrid ARMs carry a fixed rate for the first three, five, seven or 10 years, then adjust annually thereafter.

For homeowners planning to stay put, the current low interest rates make a long-term loan a good choice. "Today is a great time to get a fixed-rate mortgage if you are planning to stay there for some time. It's probably the best time in 40 years," says Berkeley's Mr. Rosen. Indeed, the professor himself just locked in a 15-year mortgage in December at a 5% rate.