The window of opportunity for homeowners to take advantage of low mortgage rates and to refinance is shrinking.

The Mortgage Bankers Association of America forecasts that the average annual 30-year fixed mortgage rate will rise from 6.97% at the close of 2001 to 7.2% by the end of 2002.

Indeed, the opportunity to refinance your mortgage at current low rates is rare. The annual average 30-year fixed-rate mortgage has been below 7% twice in the past four years, in 1998 and 2001. But during the long stretch between 1972 and 1998, the rate never once dipped below 7%.

MBAA statistics show that $1.14 trillion in refinancing occurred in 2001, up from $194 billion during 2000. In 2002, the MBAA expects refinancing to fall to $521.7 billion as mortgage rates climb.

"If they go much above 7.25%, that could seriously put a dent in the refinance activity," says Phil Colling, an economist in the MBAA research and development department.

The Fixed Is In

But which kind of mortgage would be the best in the current economic climate? Because mortgages vary as much as the banks that offer them, not many financial advisers offer a definitive answer. However, many agree that a fixed-rate mortgage offers low risk at a great price.

"Any time when rates are at historical lows, it makes sense to lock in a fixed rate for whatever period of time you want to be in your homes," says Nancy Anderson, a chartered financial analyst with New Perspectives in Clinton, Miss.


Last Chance?
How low can 30-year fixed-rate mortgages go?
Year Average Annual Rate
2001 6.97%
2000 8.05
1999 7.44
1998 6.94
1997 7.60
1996 7.81
1995 7.93
1994 8.38
1993 7.31
1992 8.39
1991 9.25
1990 10.13
1989 10.32
1988 10.34
1987 10.21
1986 10.19
1985 12.43
1984 13.88
1983 13.24
1982 16.04
1981 16.63
1980 13.74
1979 11.20
1978 9.64
1977 8.85
1976 8.87
1975 9.05
1974 9.19
1973 8.04
1972 7.38
Source: Freddie Mac

But the time to refinance is still ripe. The current 30-year fixed mortgage rate is at 6.49%, and the 15-year fixed rate is at 5.95%, according to the most recent data from mortgage-tracker Bankrate.com. A one-year adjustable-rate mortgage (ARM) goes for 4.88%.

A more pressing question is whether to refinance for 15 years or 30 years.

Anderson recommends the 15-year fixed-rate mortgage because the current lower rate and shorter period of time will save homeowners money in the long run. For example, a 15-year fixed-rate mortgage of $200,000 would cost $152,000 less in interest than a 30-year fixed-rate mortgage of the same amount. But make sure you can make the larger monthly payments: The 15-year is $419 more a month than the 30-year.

Mark Kaizerman, a certified financial adviser with Kaizerman & Associates of Natick, Mass., has a more conservative approach. He advises clients to take out a 30-year fixed-rate mortgage and pay it off in 15 years. Using the same monthly payment as the 15-year -- $1,682 -- the 30-year would be only $18,485 more expensive than the 15-year fixed-rate mortgage, but it's possible to lower payments if necessary. "The rate difference isn't worth the added flexibility," he says. "Who knows what's going to happen?"

Some Could Take Up ARMs

But fixed-rate mortgages aren't for everybody. Let's take a look at two other options: ARM and hybrid mortgages.

Typically, an ARM mortgage begins 2 to 3 percentage points below the fixed rate, but then changes at intervals depending on market conditions. For example, a 5-1 ARM offers a fixed rate for the first five years before it switches to a variable rate. A hybrid mortgage is basically the same as an ARM mortgage, but differs in that it offers the discount below the fixed rate for a longer period of time.

Because of the way that ARM and hybrid mortgages are structured, those who plan to move soon may want to consider them. "ARMs are attractively priced now," says Jack Guttentag, professor of finance emeritus at the University of Pennsylvania.

For those moving within the next five to 10 years, such alternatives to the fixed-rate mortgage offer a short-term benefit. In other words, if you can get out of an ARM or hybrid mortgage before it switches to a variable rate, you could possibly save some cash. Say you're 58 years old, with $100,000 left to pay on the mortgage. In four years, you plan to retire to a condo in Arizona. Your best bet is to take out a 5-1 ARM, which currently has a rate of 5.72%, according to Bankrate.com.

With a 5-1 ARM mortgage, you'll pay $19,845 in interest for the first four years, which is better than the $22,577 you'd pay under a 30-year fixed-rate at the current levels. The only risk is that if, by some chance, you do stay in your home past the expiration of the fixed-rate portion of the mortgage, the variable rate can skyrocket as much as 5 percentage points, Guttentag says. The rate could also drop lower, but that isn't likely because the rates are currently so low. Before you commit to either an ARM or hybrid, make sure you understand exactly how the rate varies, or you could be shocked when the payments jump.


Shrinking Window
Refinancing activity falls as rates climb
2000 2001 2002
$194 billion $1.14 trillion $521.7 billion*
Source: MBAA
* Projected

A Couple of Warnings

Remember also, refinancing comes with a price tag. After all the closing costs and processing fees, a $200,000 refinancing can result in nearly $3,000 in fees. "It would take you literally two years to break even," Kaizerman says. So make sure you plan to stay in your house at least that long.

And if you've got a small amount left on your mortgage, refinancing might not be for you, Guttentag says. His advice: People with less than $50,000 left on a 10% fixed-rate mortgage or less than $90,000 remaining on an 8% fixed-rate mortgage should stay put.

But whatever you do, avoid balloon mortgages at all costs. Under a balloon mortgage, a very low rate is locked in for a set amount of time, usually between three and 10 years. Once the time period is up, the entire balance of the loan must be paid or you could be forced to refinance on the bank's terms.

"Balloon loans are just a panic attack waiting to happen," Kaizerman says.