The Wall Street Journal recently asked this question in an article by James Hagerty. Some of the salient points made were:
1) In other parts of the world, variable mortgage rates are the standard. Canada and the European Union are examples. A person's mortgage payment might go up if rates increase, but the financial institutions can be certain that the interest rates they pay for CD holders etc. don't exceed mortgage rates.
2) An average borrower who will live in their home for 5-7 years is protected by using a 5 or 7 year fixed rate or balloon loan.
3) Using variable mortgage products moves the risk from the bank to the homeowner. Obviously, banks are interested in this as what has transpired in the last 18 months or so, is the opposite.
4) In Denmark, mortgages are financed through the bond market rather than the securities market, where rates are less volatile.
The current reliance on the fixed mortgage product may be seriously reviewed as we move forward where many are predicting increasing defaults in 2010. It will be interesting to see where the analysis of the recent crisis leads us.
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