No longer as much of a bargain as they were before the Federal Reserve raised short-term rates, adjustable mortgages lost some of their share of the residential market in 2006.
At the end of December, the market share for ARMs fell to 20.4 percent, the lowest since July 2003, according to the Mortgage Bankers Association of America. ARMs’ share of the market has been as high as 33 percent (in 2004) and as low as 11 percent (in 1998).
Frank Nothaft, vice president and chief economist of Freddie Mac, which buys residential mortgages and repackages them for the secondary market, said Fed action in the first half of 2006 had increased short-term rates by 1 percentage point, to 5.25.
The resulting increase in short-term mortgage rates – first-year ARMs rose 0.3 percent – narrowed the gap with fixed-rate instruments, making adjustables less of a bargain. First-year ARM rates would have risen more had lenders not increased the use of discounts.
To boost the financial incentive for borrowers to choose an ARM, lenders typically offer a lower initial interest rate than what the fully adjusted rate would be at the time of origination – meaning the underlying index rate plus the margin.
At the end of 2005, this discount averaged 1.9 percentage points for conventional, conforming one-year Treasury-indexed ARMs. And by the end of 2006, it had reached an average of 2.3 percentage points.
The last time initial-rate discounts were higher was in 1997. In the 23 years that Freddie Mac has been tracking the data, initial discounts on one-year ARMs have averaged 1.7 percentage points.
“When the interest-rate difference between a 30-year fixed-rate mortgage and the fully indexed ARM rate decreases, lenders generally offer a larger initial-rate discount on the ARM,” Nothaft said. “The larger initial discounts increase the initial rate benefit of an ARM compared with fixed-rate loans, helping lenders to maintain ARM originations.”
Brett M. Warren, president of Buyers Home Mortgage in Abington, said his company isn’t writing any adjustable-rate mortgages.
With the gap between short terms and long terms so small, Warren said, “we are able to offer a 30-year fixed-rate mortgage at 5.875 percent with no points, which is almost identical to a 3/1 or a 10/1 adjustable. So why not go fixed?”
A point equals 1 percent of the amount of a mortgage. If a mortgage is $100,000, a point would be equal to $1,000 (fully deductible on a purchase in the year the loan is closed).
Known as a “hybrid,” a 3/1 adjustable mortgage has an initial interest rate for the first three years, and then adjusts annually. Each annual rate adjustment is based on another rate, typically the yield on a Treasury note.
The initial rate on a 10/1 adjustable lasts for 10 years.
One-year adjustables have been hovering at 5.5 percent, with five-year hybrids around 6 percent with about half a point, according to Freddie Mac.
Hybrids have become much more popular than one-year adjustables, and for good reason.
“A 5/1 hybrid ARM provides the consumer the comfort of knowing that the interest rate will be fixed over the first five years of the loan,” said Nothaft, offering an example. “However, the interest rate may jump as much as 5 percentage points on the fifth anniversary. Thus, the product has been popular with families who plan to have the mortgage for five years or less.”One major change that the mortgage industry has been tracking is the shift to interest-only fixed-rate loans.
With an interest-only loan, the borrower pays only the interest that accumulates on the loan balance, which does not decrease. At some point in the life of the loan, payments do rise, however, and the borrower begins paying against both the principal and the interest.
In the first half of 2006 – the period for which the Mortgage Bankers Association has the most recent data – interest-only loans accounted for 26 percent of all mortgages. But fixed-rate interest-only loans accounted for 24 percent of all the “I-Os,” compared to 13 percent in the second half of 2005.
“A lot of the adjustable I-Os have disappeared from the marketplace,” said Warren, with not a bit of regret in his voice. “We like some of the fixed-rate products, but not the adjustables because they come with a lot of uncertainty.”
Copyright © 2007 Philadelphia Inquirer, Al Heavens. All rights reserved. http://www.floridarealtors.org/NewsAndEvents/n5-012207.cfm
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