Americans are Dis-ARMing, according to new Freddie Mac research

by Kenneth R. Harney

It's official: American home buyers and refinancers are dis-ARMing at a rapid pace. Freddie Mac's newly-issued survey of adjustable rate mortgages found that the ARM share now stands at just 25 percent, down from 33 percent in 2004. In the mid- 1980s, by contrast, ARMs were the most popular financial tool for buying a house, with a 62 percent market share.

Why the dis-Armament movement? It's all about rates: one-year adjustables tied to a Treasury index went for an average 5.79 percent last week, according to the Mortgage Bankers Association of America. Fifteen-year fixed-rate loans, by comparison, cost 5.85 percent on average, and 30-year fixed-rate loans went for an average 6.13 percent, with roughly similar discount points.

Who wants to risk potentially wrenching rate increases every year for the life of the loan when they can lock in peace of mind and predictable monthly payments with today's low long-term fixed rates? Almost nobody, according to Freddie Mac chief economist Frank Nothaft.

That's why traditional one-year ARMs represent a tiny sliver of the ARM market itself. Most adjustables closed last year were some form of "hybrid" offering an initial period where the rate and payments are fixed -- typically for three or five years -- followed by a conversion to a one-year ARM for the balance of the term.

Freddie Mac's annual ARM survey found that barely half of all mortgage lenders who offer ARMs even bother to sell the traditional one-year model. That's the lowest offering rate in 23 years, and a portent of where the one-year adjustable may be headed, absent fundamental changes in capital markets interest rate patterns.

By far the most popular ARM is now the "5/1" hybrid, according to Nothaft. The 5/1, which averaged 5.96 percent in the survey, fixes the rate for the first 60 months of the loan, then converts to a oneyear ARM.

"A 5/1 hybrid provides the consumer the comfort of knowing that the interest rate will be fixed" for a set period, and that's the reason why the concept "has been popular with families who plan to have the mortgage for five years or less," said Nothaft.

Most borrowers who take out 5/1s expect to refinance, sell or otherwise pay off the loan before the rate reset date. The same is true for the 3/1 hybrid, which comes with a slightly lower initial rate. ARMs may be declining in popularity in the overall national marketplace, but new research by the Mortgage Bankers Association finds that they still have substantial followings in certain niches.

For example, ARMs accounted for 59 percent of the subprime sector last year, where borrowers have less-than-perfect credit profiles. Many subprime borrowers opt for 2/28 adjustables that offer low, fixed payments for the first 24 months, and typically are refinanced at the twoyear anniversary date.

Certain states have a higher than average appetite for ARMs as well. In Nevada, according to the mortgage bankers study, 42 percent of the market last year went to adjustables. In California, 38 percent of new loans were ARMs and in the District of Columbia 35 percent were adjustables.

All three of these jurisdictions had higher than average origination rates for so-called payment-option ARMs that allow borrowers to cut payments drastically for limited periods before the loan resets upward. Many of those mortgages are headed for major payment resets this year and next, however, and large numbers of are expected to shift into fixed rates in advance of the resets.

Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consumer credit and banking industry regulation.