ortgage rates have been on a downhill slide in recent months, edging toward historic lows by fourth quarter of 1998. Consumers watch and wonder: How low will rates go?

If you're holding an adjustable-rate mortgage (ARM), certainly that's a question you're pondering a lot these days. You're hoping to hit the optimum time to convert your ARM to a fixed-rate mortgage.

By early October, the fixed rate on a 30-year mortgage had fallen to 6.59%, and the 15-year rate was at 6.28%, according to Bank Rate Monitor. No one knows for sure, of course, whether or how much further interest rates will drop. But experts strive to make their best guesses. Steve Rick, an economist with CUNA & Affiliates' economics and statistics department, predicts that 30-year mortgage rates will fall to 6.5% well before year's end, and, he adds, "They have a decent probability of going below 6.5%."

So, if you have an ARM, should you convert to a fixed rate now, or wait a little longer? In deciding when to make your move--or whether to convert at all--you should look at several factors.

Will you live in
your house long
enough to recoup
conversion costs?
What will rates do?
A first step is to educate yourself about the current rate climate and what economists foresee for the coming months. A lot will depend on what happens in other parts of the world. That's because the rates for 15-year and 30-year mortgages are tied to the seven-year and 10-year Treasury notes respectively. In the current world economic climate, U.S. Treasury securities hold high appeal to investors shying away from Asia and other markets currently in turmoil.

"The world views the U.S. as a safe haven now for investments," Rick explains, "so everybody wants to buy our bonds. That pushes up the price of bonds and reduces our interest rates. So what's driving down our fixed-rate mortgages is what's happening in the world and in the bond market on Wall Street."

If Southeast Asia, Japan, and Russia continue to have economic problems, expect rates for mortgages to continue to drop. "But if those parts of the world straighten out their financial situations," Rick says, "our rates will start heading back up." That's partly what happened in mid-October when rates moved up after Japan announced plans to strengthen its financial markets.

How long will you stay in your home?
If you have a low-rate ARM now and plan to remain in your home only a couple more years, it may not be worth your while to convert to a fixed rate. You may be ready to move on to another house before your ARM rate ratchets up to the then-going rate for a fixed-rate mortgage.

For example, say you now hold an ARM at 5.5%. It has an adjustment period of three years, meaning the rate can go up or down after three years, and your interest-rate change is capped at two percentage points per adjustment period. After three years, your mortgage rate could be up to 7.5%. Now say that the 30-year fixed rate falls to 6.5% sometime during that three-year period. If you plan to move before the three years are up, you're still better off keeping your 5.5% ARM.

"If this is the home you're going to raise your children in and stay in for 20 years, then, yes, you'll want to lock in on a fixed rate," Rick says. "But if this is your starter home and you plan to move in a few years, consider staying with the adjustable rate."

Educate yourself about
the current rate
climate and what
economists foresee for
coming months.
What will it cost to convert?
When you convert from an ARM to a fixed rate, you're in effect taking out a new mortgage. That means you'll have to pay upfront costs--including points, an origination fee, an appraisal fee, and title search charges--just as you did when you got your original mortgage.

You may be spared some of those expenditures, however, if it hasn't been that long since you closed your current mortgage. For example, a new appraisal and title search may be unnecessary because the earlier information still is current enough.

Whatever your costs add up to be, you'll need to weigh them against the interest savings you gain by converting. Say your costs total $1,000 and you pay $50 less in interest each month after converting to a fixed rate. After 20 months, you'll have recouped your conversion costs. Here again, length of stay in your house is the deciding factor. Will you live there long enough to reap the payback?

Remember, Rick emphasizes, when comparing conversion costs and savings "look at just your interest savings, not your savings in the overall monthly mortgage payment. Part of that payment is for principal."

You also may want to avoid out-of-pocket expenses by adding the points and closing costs to your new mortgage. If you've had your current mortgage for at least three years, you've probably reduced your balance enough to tack on some costs and still end up with a smaller mortgage payment than before.

Switch to another ARM?
Currently both fixed and adjustable mortgage rates are falling--but not at the same speed. That's because each is affected most by different economic forces. While
15- and 30-year fixed rates react to the bond market, adjustable rates depend on decisions of the Federal Reserve Board, which greatly influences short-term rates. "If the Fed lowers rates," Rick explains, "that will affect an ARM, but it has little effect on your typical fixed-rate 30-year mortgage."

ARM rates have fallen much less dramatically than fixed. The upshot is that the differential between fixed and adjustable rates now is slim, compared with a few years ago. While then it was common to find an ARM at three percentage points less than a fixed rate, the difference in early October 1998 was only about one point (5.54% for an ARM vs. 6.59% for a 30-year fixed, according to Bank Rate Monitor). "The difference between the two is compressed," Rick notes. "So ARMs don't have as much rate advantage as they used to."

Even so, it may make sense for you to switch from your current ARM to a new one, rather than converting to a fixed-rate mortgage. You may be able to find an ARM with better terms. For example, perhaps you could switch from an ARM with a one-year adjustment period and a two percentage point annual rate cap to a one-year ARM with a one percentage point annual rate cap.

Again, deciding whether this is the right choice for you depends on two key factors: how long you expect to remain in your home and what you'd pay to convert to a new ARM.

Get ready, set...
If you think you'd like to convert your ARM, talk to someone at your credit union to get the process rolling. You can complete the paperwork now and, if you choose, wait 30 days to 60 days--perhaps even longer--to lock in a rate. Whenever you decide the time is right, you'll be ready to make your move.

©1998 Credit Union National Association, Inc.