Higher Rates Should Lead to ARM Resurgence Freddie Mac Says

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Adjustable
rate mortgages
remain at historic lows Freddie Mac said today as the company
released results of its 30th Annual
Adjustable-Rate Mortgage (ARM) Survey of prime loan offerings.  The 1-year ARM has remained essentially
unchanged since last year’s survey while initial period rates on hybrid loan
products rose. This, Freddie Mac said, largely reflects term structure
movements in the rest of the capital markets and the Federal Reserve’s
monetary policy, which has kept the federal funds rate and other
short-term interest rates exceptionally low while allowing a rise in
medium- and longer-term interest rates from last year.

Hybrid ARMs have a fixed rate for an
initial period ranging from three to 10 years and then adjust annual
thereafter.  Nearly all of the ARM
lenders participating in the survey offered a hybrid with the 5/1 far and
away the most common of the products both in terms of availability and use, followed
by the 3/1, the 7/1 and the 10/1.  Less
common are ARMs with longer repricing periods such as a 5/5 which features rate
adjustments every five years for the life of the loan.

The survey, which was conducted
January 6 to January 10, showed that the largest rate increases were for
hybrids
with longer initial fixed-rate periods. 
The 7/1 ARM rose by 0.71 basis points  from last year and the 10/1 was up 0.76 basis
points. 

The savings in early January 2014
for a borrower taking a 30-year 5/1 hybrid ARM instead of a 30-year fixed rate
mortgage (FRM) was about 1.36 percentage points.  This would result in a monthly principal and
interest payment during the first five years that is about $194 less than for
the fixed rate for a $250,000 loan.  

Frank Nothaft, Freddie Mac vice
president and chief economist said, “Homebuyers have preferred fixed-rate
mortgages the past few years because of the low interest rates and the
certainty of the monthly principal and interest payment. As longer-term
rates rise, ARMs with their lower initial interest rates will become more
appealing to loan applicants. Hybrid ARMs are particularly attractive because
they have an initial extended fixed-rate period of 3 to 10 years.”

Freddie Mac surveyed 106 ARM lenders
and found that 84 offered ARMS indexed to Treasury bills and 22 offered London
Interbank Offered Rate (LIBOR)-indexed ARMs.  The company said that generally large
national lenders offered LIBOR based loans while community and regional lenders
were more likely to offer those based on Treasury indices.  Thus, even though offered by fewer
lenders, the LIBOR-based product accounted for more than one-half of
ARM originations. LIBOR-indexed ARMs generally had a lower margin
(about 0.5 percentage points lower) than Treasury-indexed ARMs, a similar
initial interest rate, but a higher index rate (about 0.5 percentage points
higher).

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