Adjustable loan back in favor

Cheaper: The rise in fixed-rate loans has renewed interest in mortgages with adjustable rates. ARMs now finance nearly half of new homes.

January 23, 2000|By Robert Nusgart | Robert Nusgart,SUN REAL ESTATE EDITOR

Fact: Since October 1998, when fixed-rate mortgages could be found at 6.5 percent -- a 31-year low -- rates have been steadily climbing.

Fact: The 30-year, fixed-rate mortgage is at its highest level in more than three years, hovering around 8.5 percent.

Fact: Adjustable-rate mortgages, all but forgotten 18 months ago, are flexing their muscles once again.

According to Freddie Mac, the federally chartered organization that supplies funds to lenders by purchasing mortgages, 30 percent of all single-family home loans are expected to be financed through an adjustable-rate mortgage, or ARM, through the first quarter of 2000. It expects the share to rise to 35 percent by midyear. Narrow the field to new homes, and the ARM share climbs to almost 50 percent.

In 1998, adjustable-rate mortgages accounted for just 8 percent of the market. Today, the interest rate for a one-year ARM in the Baltimore metropolitan area is averaging 6.18 percent, compared with 8.25 percent for a 30-year fixed-rate mortgage, the highest it's been since Sept. 27, 1996.

Nationally, according to Freddie Mac's weekly survey last week, the 30-year, fixed-rate mortgage averaged 8.26 percent, the highest since Sept. 13, 1996.

So even though that 6.5 percent or 7 percent fixed-rate mortgage is history, lenders are making sure that homebuyers will still be able to get a low rate if they are willing to take some risk.

"We will be doing a lot of ARMs, I can tell you that," said Neil Sweren of AllyMac Mortgage in Owings Mills.

With prices for new and existing homes steadily climbing -- along with interest rates -- it's easy to see why buyers are increasingly turning to ARMs to allow them to qualify for a purchase.

Rising interest rates result in smaller fixed-rate mortgage amounts. A borrower who qualified for a $150,000 loan at 7.25 percent last year -- with all other factors being equal -- would qualify for only a $136,200 loan based on a fixed rate of 8.25 percent. But with an ARM, he can borrow more because less of the loan will be for interest.

Today, buyers have a menu of ARM entrees to choose from: one, three, five, seven, even 10-year loans are available.

Each ARM balances interest rate vs. risk -- the shorter the term, the lower the initial rate; the longer the term, the higher the starting rate.

For instance, a 7/1 ARM will maintain the same interest rate for the first seven years. But beginning in year eight the lender will use an economic indicator to add a margin and arrive at a new rate for the borrower. Most ARMS have a cap on how high the rate can be raised annually and over the life of the loan. The loan is similarly adjusted every year thereafter.

But all in all, each ARM gives the consumer a rate lower than the prevailing 30-year fixed rate, which means real dollar savings.

If a homebuyer doesn't like the prospects of going into an ARM, he might be interested in a "2-1 buydown" that combines the initial low rate of an ARM with the stability of a fixed-rate mortgage.

Dr. Courtney Perez, 33, and her husband, Tomas, 35, did the exotic by combining a five-year ARM with a buydown program when they purchased their Sparks home after moving from San Francisco last year. "The fixed rates were a little higher than what we wanted," she said. "Since we're young, we were projecting our salaries to be going up."

In the high-flying San Francisco real estate market, the couple sold their two-bedroom condominium in the Castro district of San Francisco for $440,000, after paying $370,000 for it three years ago. When she took a job as a radiologist here, the couple was able to purchase the five-bedroom home on three acres in northern Baltimore County for $460,000.

At first she was looking at an ARM that would adjust every month, but would carry a low initial rate, around 4 percent.

"I hadn't really heard of this type of program. So I educated myself," the doctor said. "I started calling around and went on the Internet and got all these different rates. And I found as I called people, no one could really explain it to me. By the time I realized that [it] wasn't going to work for us, I had educated myself and was a little more savvy."

A loan officer at AllyMac suggested that perhaps the best way to finance the Perez loan of $436,500 was to go with a 5/1 ARM and combine it with a 2-1 buydown. In a typical five-year ARM, the initial rate stays the same for the first five years and then adjusts annually beginning with the sixth year.

But with the "buydown" the Perezes paid a little more in points to the lender (a point is equal to 1 percent of the loan amount) and "bought" the initial note rate down from 8 percent to 6 percent for the first year. In the second year their interest rate will rise to 7 percent -- hence the 2 then 1 -- and years three to five will carry an interest rate of 8 percent.

"I liked that because it gave us a little breathing room for a couple of years and also we know exactly how much we are paying," she said.

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