BOULDER, Colo. -- It's no secret: Home mortgages are cheap. You can now find 30-year, fixed-rate loans as low as 7 3/4 percent. And if you are really diligent, you can go even lower, down to 5 percent or 5 1/2 percent, by taking out an adjustable rate mortgage.
In the rush to refinance out of double-digit mortgages, most homeowners choose fixed terms. But for some borrowers, ARMs are an attractive alternative. The catch is to not use such a loan to buy more house than you can afford. The Federal National Mortgage Association, the nation's largest supplier of mortgage money, wants to make sure you don't.
With that in mind, Fannie Mae has tightened some standards for adjustable rate mortgages, to make sure that borrowers don't get in over their heads because of the attraction of very low "teaser rates."
Typically, ARMs offer very attractive initial rates, usually one or two points below the prevailing market rate. Adjustments are made regularly, usually at intervals of one, three or five years. In return for taking some of the risk of a rise in interest rates, borrowers get lower rates at the beginning of the ARM than they would if they took out a fixed-rate mortgage covering the same term.
With conventional rates so low, some lenders are offering adjustable rate mortgages for 5 percent to 5 3/4 percent for the first year. But, those loans will rise in the second year, said Bonnie O'Dell, a spokeswoman for Fannie Mae.
Fannie Mae last month told lenders that it will not buy adjustable rate mortgages with these very low interest rates unless the borrower can qualify for the mortgage as if it carried an initial rate of 7 percent.
"What we're trying to say is that in this interest rate environment, consumers are more likely to see mortgage rates go higher rather than keep dropping. When you get a rate substantially below an already low market rate, you are going to have to see mortgages drop by another 2 points just to keep your ARM from rising," Ms. O'Dell said.
"We think consumers must be prepared to pay that higher rate because they are definitely going to have to pay it," she said.
"Rates have dropped so far, so fast, that what Fannie Mae did was prudent," said Kevin Iverson, president of the Colorado Mortgage Bankers Association. "They have stepped in quickly, before anything could get out of hand, to make sure that buyers aren't getting into a situation that they can't really afford."
He said the the impact will be limited, at best, because conventional rates are so low. And, he said, 7 percent is still a very attractive rate.
However, Chuck Ohmer, Western divisional manager for Norwest Mortgage Inc., worried that some buyers who would qualify under a 5 percent loan won't be able to get one at the 7 percent rate.
"That disturbs me. But it also means that it might keep someone from buying a house they cannot afford," he said.
The difference in what a borrower can buy can be significant. With a 5 percent mortgage and a 10 percent down payment, a buyer with $30,000 a year income could afford a $130,000 house. At 7 percent, with the same down and the same income, he could only afford to buy a $105,000 house.
If you are thinking about refinancing your mortgage, this the time to do it, Mr. Ohmer said. You can move the process along faster if you come prepared with:
* A copy of your signed purchase agreement;
* W-2 forms for the past two years;
* Last two months' bank statements;
* Names, addresses and account numbers from all creditors;
* Pay stubs from the last 30 days;
* 12 months' of canceled checks on your prior mortgage or lease.
To this information, the lender only has to add a credit report and an appraisal of the property.