Buyers heed call to ARMs

Adjustable-rate loans go from 12% to 30% of market

Low cost appeals to many

January 18, 2004|By Patricia Rivera | Patricia Rivera,SPECIAL TO THE SUN

Ondrea Clay found the offer too good to pass up.

A lender promised an adjustable-rate mortgage that would reduce her monthly mortgage payments by $400. The only catch was that the 5 percent interest rate would last for three years, after which it would revert to a rate prevailing at that time.

She took the offer anyway.

"It's still a big savings," said Clay of Randallstown.

Despite extraordinarily low rates on fixed mortgages, a growing number of borrowers are choosing even lower-rate, short-term loans known as adjustable-rate mortgages, or ARMs.

After months of seeing the rates for long-term mortgages hit all-time lows last year and home prices growing by double-digit percentages, some homebuyers are opting for the adjustable-rate loans to secure the lower interest rates and more affordable monthly payments.

About 30 percent of the nation's borrowers are choosing ARMs, up from 12 percent at this time last year, according to the Mortgage Bankers Association of America.

Financial and consumer experts say the percentage is expected to rise even more this year, especially since many lenders are pushing them. Experts say lenders are working to increase their ARM portfolios, which had become depleted as consumers turned to longer-term loans to refinance their homes.

The increase in the popularity of ARMs is based in part on the prediction that 30-year fixed mortgage interest rates will average 6.2 percent this year and hit 6.5 percent by year-end, according to the Mortgage Bankers Association of America.

"Consumers are looking for tools that will make their purchase more affordable, and that is why they consider an ARM," said Douglas G. Duncan, an economist with the association.

The wild card is that adjustable-rate mortgages fluctuate with market conditions.

"There are some people on the cusp of affordability where an ARM makes sense," said Greg McBride, a senior financial analyst with "But it's really for borrowers who will only be in a home for a period of less than 10 years."

McBride and others advise homebuyers to study the loans carefully, because they often offer a lower mortgage rate upfront. But they point out that a fixed-rate loan could be a better bet for long-term borrowers because many economists expect rates to rise in the coming months and years.

"Fixed rates are incredibly low right now - there's no sense in putting yourself in a pinch later if you're not sure how long you'll be in the home," McBride said. "Where selecting at this juncture is very dangerous is when the decision is made on payment affordability. If you cannot afford the mortgage payments when interest rates are below 6 percent, you're not looking at the wrong loan, you're looking at the wrong house."

A borrower who gets a five-year ARM and stays in the home longer could see some of the initial savings from the lower interest rate wiped out, said Keith T. Gumbinger, a vice president of HSH Associates, a New Jersey company that studies mortgage rates.

Though borrowers opting for adjustable-rate loans have increased, the number remains small compared with those who choose fixed-rate loans.

Experts point out that the majority of homeowners choose 15- or 30-year loans because the interest rate stays the same. Some economists said the adjustable rates are good for buyers who know they won't be staying in a home for decades, as was often the case generations ago.

"There is an adjustment period," said Frank Nothaft, Freddie Mac's chief economist. "People have gotten spoiled in the last three to four years [by the low interest rates]. No doubt people will think it's something new, but it's not."

ARMs were introduced during the 1980s, when fixed-rate mortgages were at or near the record high of 18 percent. With fixed-rate mortgages becoming unaffordable, mortgage lenders created the adjustable-rate loan to keep the housing market afloat, Gumbinger said.

"Short-term ARMs became popular with folks who liked the opportunity for a lower rate down the road," said Gumbinger, noting that most borrowers were betting that rates would fall during the 1980s. "Longer-term ARMs found favor among those who feared frequent rate changes and the uncertainly they brought to a budget."

Today, consumers can choose from a variety of adjustable-rate mortgages, including hybrid ARMs that give borrowers a fixed rate for a certain number of years and then are adjusted to reflect current interest rates but with limits. If the rates have gone up, the homeowner pays more each month. If the rates fall, the homeowner pays less.

Adjustable-rate loans are especially popular with borrowers who plan to stay in their homes for a set, usually short period.

Most homeowners are more comfortable with a mortgage that has a fixed rate for its whole term than with a loan whose rate could rise sharply, Gumbinger said, but even experts say ARMs can cost less than fixed-rate mortgages over the same period.

A homeowner can always refinance an ARM, but that entails shopping for another loan and paying closing costs that can reach into the thousands.

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