This year's hikes in long-term rates have put a chill on fixed-rate loans and brought adjustables back with a flourish. While still a bit standoffish, the secondary markets are more willing than ever to buy them.
At Great Western Bank in Chatsworth, CA, adjustable-rate mortgages represented 65% of closed loans in January. By June, that percentage had soared to 95%.
At Chase Manhattan Personal Financial Services, Chase's jumbo mortgage subsidiary, ARMs recently made up almost two-thirds of the product in the pipeline, with fixed-rate loans one-third, says its president, Thomas M. Garvey A year ago, those proportions were roughly reversed.
From around the country, the evidence is piling up: ARMs are back, big-time. Th Federal Housing Finance Board reported that 43% of home-purchase first mortgage closed in June were ARMs, up from 36% in May and 23% in March. (The FHFB data, based on a national survey, excludes refinancings.) The ARMs' share is the survey's highest since June 1989. And 14% of homeowners refinancing 30-year fixed-rate loans purchased ARMs in the second quarter--the highest share since 1988, according to Freddie Mac.
What's behind the surge? Simply put, rising rates. After a stable period of low long-term rates sent the popularity of fixed loans soaring, especially for refinancing homeowners, the pendulum has swung the other way. Average rates on 30-year fixed loans had ratcheted up steadily since February--rising 48 basis points in May alone--to 8.6% by early August, following the series of hikes by the Federal Reserve aimed at checking inflation.
The big rate run-up, pushing 200 basis points, has slammed a lot of mortgage bankers, most of whom are fixed-rate specialists. Many are laying off staff or even selling out. Those that are committed to staying in the business are furiously trying to add adjustable-rate products to their lineup.
The biggest beneficiaries of the rate hikes have been savings institutions, the portfolio lenders who have historically been the chief adjustable vendors. They're either originating themselves or buying from those mortgage bankers tha have managed to create ARMs. They've also had some success selling to Fannie Ma and Freddie Mac, who have been adding adjustables to their buying programs as fixed-rate volumes have plunged.ARMs State a Comeback Percentage of New Loans With Adjustable Rates Percentage September '93 17%October '93 18%November '93 19%December '93 23%January '94 24%February '94 21%March '94 23%April '94 31%May '94 36%June '94 43% Source: Federal Housing Finance Board
As this year has amply proven, rising rates can still knock the mortgage market for a loop. But increasingly, lenders are becoming more sophisticated and resourceful, pricing adjustable mortgages off Treasury bills, the London Interbank Offered Rate (LIBOR) or regional cost-of-funds indexes. Too, many current ARMs offer below-market fixed rates for as long as seven years--giving someone likely to move in a few years a compelling rate break.
Plain vanilla is out; bells and whistles are in. Chase Manhattan Mortgage, for instance, introduced a six-month ARM in June tied to the six-month T-bill. Borrowers get lower initial rates for the first six months, then a rate that adjusts every six months, with a 1% cap per adjustment. The loan has an extende rate-lock option, no prepayment penalty and a conversion option to a fixed-rate loan any time between the 13th and 60th month.
Chase tries not to promise customers a host of different rate structures, but concentrates "on a few products that the market demands," Garvey says.
Adjustables tied to the 11th District Cost-of-Funds Index, a favorite of West Coast thrifts like Great Western, are popular and successful. Mortgage brokers like North American Mortgage of Santa Rosa, CA, say they're working to add loan tied to that rate. Adjustables pegged to cost-of-fund indexes tend to lag broader moves in interest rates, a particular advantage when rates are moving up.
Since the first wave of ARMs rode in during the '80s, consumers have blown hot and cold on them. They've embraced ARMs when rates soared--adjustables represented 58% of all new conventional mortgages in 1988, when rates on fixed mortgages stood over 10%, according to the FHFB--but often see them as merely the lesser of two evils. Borrowers don't like the uncertainty of variable rates especially the threat that rates could rise as much as 6 percentage points during the life of the loan, a common provision.
Cutthroat Pricing
But for lenders, the ability to capture rate hikes has been a godsend--so much so that not a few are willing to give away profits up front, proffering "teaser rates on one-year ARMs (some under 4% these days) to bring in business. This cutthroat pricing has alarmed regulators: The Office of Thrift Supervision's Western Region issued a warning letter about setting initial rates too low.
Sam Lyons, senior vice president for mortgage banking at Great Western, says he's heard of "some isolated cases" of such pricing but says there's little sig of it California. Still, things are "very, very competitive."
Historically, the secondary market agencies have had minimal appetite for ARMs, and adjustables still represent a meager portion of their buying. At Fannie Mae for instance, just 5.2% of loans purchased in May were ARMs. Yet Fannie announced in June that is was adding a 10-year fixed-period ARM, where the rate is set for the first decade at a level lower than a conventional loan, then adjusts annually based on an index tied to one-year Treasuries.
Fannie also buys 3-, 5-, and 7-year fixed ARMs--and a loan tied to LIBOR that resets every six months over 30 years, with changes capped at 1% each adjustmen period. Yet its faith in fixed loans is unshaken. While acknowledging that ARMs will increase in popularity, "given the historically low interest rates we have today, the 30-year, fixed-rate mortgage will be the mortgage of choice for the vast majority of consumers during 1994," says Donna Callejon, Fannie's senior vice president for single-family marketing.
Freddie Mac spokesman Douglas Robinson says the agency is buying armfuls of ARM and has used as many as 100 different indexes. "A lot of these are negotiated transactions," he says. Freddie buys conventional ARMs in its cash program, including those with 1% annual/5% lifetime caps and 2% annual/6% lifetime caps. In its structured transaction area, it buys ARMs pegged to LIBOR, Treasuries an cost-of-funds indexes and swaps them out.
Mortgage banking firms are having some success originating ARMs, with 27% of loans closed in June being adjustables, up from 21% the month before and triple the percentage of six months earlier. In comparison, ARMs represented 71% of loans closed in June by S&Ls; 62% at mutual savings banks; and 44% at commercia banks, says the FHFB.
But mortgage banks are finding the going especially tough in the West. "This market is dominated by a unique product," says Lyons, referring to the 11th District COFI ARM. It's complicated, and "mortgage bankers don't have the servicing to handle that."
What's helping to sell ARMs, bankers say, are not just higher fixed rates but the flexibility and variety now available in ARMs and consumers' recognition that adjustables are less and less a crap shoot on interest rates.
"There are a variety of lenders who are trying to carve out a little niche for themselves by doing something a little different--tweaking the product, if you will," says Robert Ventimiglia, senior vice president for mortgage banking at Boatmen's National Bank in St. Louis. "And customers are looking closely. The customer is more educated than he was two or three years ago."
