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Time to lock in mortgage rates?

Plans to build a new home

Question: I bought a condo in Bozeman, Mont., 7 years ago using a 5/1 ARM. When the 5-year period ended, I let it roll over into a 1-year ARM because the rate went down from 4.5 to 3.25. Then, last year, I did the same -- only from 3.25 to 3 percent. Come March, the 1-year period will expire again and I wonder if I should let this happen again, since rates will probably be low. Or should I bite the bullet, pay approximately $2,500 in closing costs to lock in a low rate for 15 or 30 years, but make higher payments? (My payments are ridiculously low.)

The four-unit complex is 100 percent non-owner occupied, so re-fi rates are not favorable to me. The balance is $38,000 and I have two other mortgages. I am due to begin building a new home within the next year. I feel that, if need be, I could pay it off if something went haywire, though I know that's not a financially savvy thing to do. Should I do something different or let sleeping dogs lie? Thank you. I love listening to the show.  Cindy, West Yellowstone, MT 

Answer:  You're running a small real estate business. (And in one of the most beautiful parts of the country; it has been a long time since I've been there, but I have fond memories of Bozeman.) This is less a question about a mortgage and more an issue about your business. What I can offer is a perspective on thinking through your financial question. Rather than focus on the outlook for interest rates, I would concentrate on risk. Specifically: managing the risks of your small business.

Full disclosure: I predicted on public radio in late December 2010 that mortgage rates would rise in 2011. I thought the housing market and the economy would have enough vigor to push rates up slightly during the year. Got that one wrong! I have the same outlook for 2012. I wouldn't be surprised if mortgage rates went lower in the first few months of the year, but I still expect rates to go higher as consumers decide it's time to go bottom-fishing for homes in an improving economy. I'm far from alone in predicting a slightly better economy in 2012, compared to last year. It's a reasonable (conventional?) expectation. We'll see what happens.

Odds are you'll get at least another year of a low rate on the mortgage if you keep your current adjustable-rate mortgage. Still, the word risk comes from the old Italian word risicare, which means to dare. "To dare reminds us that the essence of risk is about making decisions or choices with unknown outcomes," writes the late Peter Bernstein in his magisterial history of finance, Against the Gods: The Remarkable Story of Risk. "At its heart, risk management means considering the consequences of each choice we face." 

We can't piece the investment fog of the future, whether it's the outlook for interest rates, the stock market, economic growth, and so on. There's no certainty. With that in mind, I would run the numbers on your investments to figure out how serious the financial consequences would be to your cash flow and balance sheet if it turned out you bet incorrectly with this mortgage. With plans for a new home and your other properties, would you purchase some cash flow certainty and lower financial risk by locking in a mortgage rate now -- or not? Would it make more sense to roll the dice on the adjustable-rate mortgage and hold off on building a home if the bet goes wrong? 

These are the kind of risk management questions I would ask and then decide what risk profile you're most comfortable with. 

About the author

Chris Farrell is the economics editor of Marketplace Money.

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