Rising Rates Prompt
Banks to Push ARMs
April 15, 2002 -- With mortgage rates rising, banks are issuing a call to ARMs.
ARMs, or adjustable-rate mortgages, carry lower rates than traditional fixed-rate mortgages. But they also carry higher risks for borrowers -- especially if rates continue their upward path.
That isn't stopping the banks, which are pushing a dizzying array of adjustable-rate mortgages. All offer a low interest rate for a set period of time -- anywhere from a month to as long as seven years -- and then "adjust" at regular intervals afterward depending on market conditions.
In March, 15% of new mortgages were ARMs, up from a recent low of 9% in October. But if rates keep rising, Fannie Mae estimates 20% of new mortgages will be ARMs by summer.
Lenders have a lot riding on rising ARM sales. In 2001, Americans refinanced a record $1.1 trillion of mortgages, but this year refinancings should drop to $700 billion, according to Fannie Mae, which buys and packages mortgage loans. The ARMs are "another way of extending the refinance boom," says Steve Majerus, senior vice president of capital markets at E-Loan Inc., an Internet lender.
Adjustable-rate mortgages become more popular when interest rates rise, and they make sense for some borrowers, especially those that don't intend to stay in their houses long. The problem for everyone else, however, is that ARMs generally work best when interest rates are at or near their peak, because that is when borrowers stand the best chance of getting a loan that won't adjust upward later. "When interest rates are near their historic lows, there's probably only one place for them to go in the foreseeable future -- the period you'll be in the mortgage -- and that's up," says Keith Gumbinger, a mortgage analyst at HSH Associates, a financial publisher in Butler, N.J.
Indeed, the current average for a 30-year fixed-rate mortgage, though up from last year's low of 6.45%, is quite affordable by historical terms at 7.13%, according to Freddie Mac, the huge mortgage finance company. In 2000, mortgage rates got as high as 8.64%, and years ago, in the 1980s, mortgage rates at times surpassed 16%.
Still, that isn't stopping lenders from touting their ARMs. E-Loan recently introduced several "interest only" ARMs that allow borrowers to pay no principal for 10 years. The loans feature a fixed low interest rate for a set period of time, in some cases as short as six months, and then adjust afterward on a regular basis. The result is to sharply lower monthly payments at first, allowing homeowners to afford more expensive homes, an E-Loan spokeswoman notes.
However, as the name implies, buyers build no equity in the early years of an interest-only loan. Thus, if housing prices slide, buyers could end up owing more money than the house is worth.
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