When asked what interest rates are going to do, my answer is always the same: they will go up and down. I am not being flippant in my response. Interest rates went up from the early 1930s until 1981. During most of that time—over forty years—they went up in a predictable, gradual fashion, going up two or three points, then down one or two points every several years. Only at the end of the cycle, in the late 1970s, did they spike, and this is what everyone remembers. Since the inflation-induced highs of the late 1970s, they have been coming down the same way they went up—down two or three points, up one or two points over several years.
If you had an adjustable rate mortgage during the last 25 years, you did very well: your monthly payment moved steadily lower as interest rates fell. Now some pundits say that the long-term trend is turning around, and, remembering the late seventies, we are looking at years of high interest rates.
Even if the long-term trend has changed, it is very unlikely that rates will shoot up immediately and dramatically, and stay high for a long period of time. The common interest rate cycle is a rise of two or three points over a period of a few years; this slows the economy and, as the economy slows, interest rates begin to fall. Over a few years the falling rates stimulate the economy. As the economy strengthens, rates begin to rise and the cycle repeats.
Long-term historical trends show that even if we are again entering a long-term era of rising interest rates, then the up two or three points, down one or two points over a period of four to seven years is the norm. The most prudent strategy is probably neither the most conservative—a fixed rate—nor the most risky—an ARM—but the choice in the middle—a hybrid fixed for 5, 7, or 10 years. The best strategy for choosing the right loan is discussed in What is the best loan for me?
