Most of you know that mortgage rates have risen considerably over the last four months. And most analysts expect rates to rise even more in the second half of 2004. I did a little poking around and found some interesting information. While nearly all types of mortgage programs and nearly all indices that drive adjustable-rate mortgages are up, the monthly LIBOR index has hardly budged. Check this out:

• The yield on the 10-year treasury bill has soared from the 2004 lows in March of about 3.60 percent to today's yield of 4.70 percent. Unfortunately, fixed-rate mortgages tend to follow the direction of the 10-year bond, so 30- and 15-year mortgage rates are up by close to one percent. That's quite a jump over such a short period.

• The yield on the One-Year Treasury Bill has jumped from 1.19 percent to almost 1.80 percent in the same time period. This means that adjustable-rate mortgages that are tied to this index have risen as well.

• The six-month LIBOR (London Interbank Offering Rate) has jumped from 1.15 percent to 1.86 percent. Similarly, mortgages tied to the six-month LIBOR have risen by the same amount.

With all of these mortgage indices up by 60 to 100 basis points or more, it's no wonder the refinance market has been squashed. And it appears that the red hot housing market may be cooling down.

However, I did notice one thing: The monthly LIBOR index has moved from 1.10 percent to 1.23 percent -- an increase of only 13 basis points. Mortgages tied to the monthly LIBOR have barely moved. When you compare a six-month LIBOR ARM to a one-month LIBOR ARM, it's not difficult to determine which is the better deal. Let's take a look.

The monthly LIBOR ARM adjusts monthly. This scares a lot of people because the borrower is subject to monthly interest rate fluctuations. The six-month LIBOR ARM adjusts every six months, giving a borrower less frequent rate volatility.

Here's the problem. Assuming a margin of two percent (the margin is the amount added to the index to determine the mortgage rate), let's compare these two LIBOR products. The one month LIBOR ARM would be at 3.23 percent (1.23 percent index plus two percent margin). The six-month LIBOR rate would be 3.86 percent (1.86 percent plus two percent).

After rounding, we have the one-month product at 3.25 percent and the six-month product at 3.875 percent. On a $350,000 loan amount, this is a difference of $182 per month in interest. So the question to ask is whether or not a borrower would be willing to pay an additional $182 every month in order to receive only six month's interest rate security. It's not worth it and let me tell you why.

First, shorter term instruments will carry a lower rate than longer term instruments. That's why the one-month LIBOR carries a lower yield than the six-month LIBOR. Therefore, a mortgage loan tied to the monthly LIBOR should always carry a lower rate. If the LIBOR indices keep rising, the monthly LIBOR mortgage will rise in monthly increments but the six-month LIBOR mortgage will jump every six months. And since the six-month LIBOR is likely to be consistently higher, the mortgage rate will also be higher.

The bottom line is that six months really isn't long enough to give a borrower reasonable protection from interest rate volatility. If you want to avoid being exposed to interest rate risk, pay for a fixed-rate mortgage. But if you want a low rate and are willing to absorb interest rate fluctuations, the one-month LIBOR is still the way to go.

Published: June 24, 2004

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, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.