Since there is a possibility, however slight, that mortgage rates will break 10%, it's useful to see what has happened in the past when rates did break this barrier and whether there was a corresponding increase in activity in adjustable-rate loans. There were three major periods that we can examine: 1974, 1978, and 1987.

The period in 1974 occurred about July as Fannie Mae net yields climbed to more than 10%. When servicing is added, street rates probably started hitting 10% by June.

However, 1974 was not a typical year. It was the period when we saw a terrible bear market that spanned 1973 and 1974. It was also marked by oil price upheavals and a CPI that broke the double-digit ranks also to register a 12.3% reading for the year. However, this example does not help us because it occurred before ARMs were available.

The second period was also an era devoid of ARMs, so it does not give much of a clue either. Fixed loans crossed the 10% line around May 1978; however, that did not seem to impair origination activity much because 1978 volume was considerably stronger than the two previous years.

Volume hit $185 billion in 1978, compared with $112.8 billion in 1976 and $162 billion in 1977. Originations peaked out for the decade in 1979 at $187.1 billion, not much higher than in 1978. Therefore, 10% rates did not seem to hamper lending activity very much. In fact, existing-home sales hit an all-time peak in 1978.

The third period was in early 1987, when rates hit 10% by May. Even so, 1987 was somewhat of a strange year itself with the stock market crash and the end of the 1986 refinance boom. Oddly enough, 1987 saw the highest origination volume ever.

It would probably remain the record if it were not for the refi boom that began in late 1990. The $507.2 billion in volume for 1987 was not exceeded until 1991, when it hit $562.1 billion. But we do have some clue as to how borrowers coped with the increase in rates in 1987.

Early in the year, when Fannie Mae's required net yields were near 9%, the ARM share of the market was extremely low - only 22% in April. By August, it surged to 50% and ran in the 60% range for the last quarter of the year, achieving a record high of 68% in December.

Does that mean the same scenario might unfold later this year if rates break 10%? No one knows for certain. However, consider this: ARMs' share of the market was only 21% in February 1994, just after rates started to climb in late October 1993. By November 1994, the ARM share of the market was over 50%.

Is it possible that ARM activity will continue to climb and not necessarily show a significant jump if rates do top 10%? There are several factors to consider: housing demand by first-time buyers, the expectations for a continued healthy economy, the behavior of the yield curve, and consumer psychology surrounding the 10% fixed threshold.

Based on the behavior of consumers and their shift toward ARMs, one would think rates had already broken 10%. As long as affordability remains an issue for some borrowers and as long as someone offers ARMs with low initial rates, activity will shift to ARMs as rates rise.

However, we must consider that maybe 10% is no longer the obstacle it might once have been. From late 1985 through late 1990, fixed rates moved into and out of the 10% range on a regular basis. Is it possible that 11% or 12% is the new psychological barrier? Only time will tell.

Mr. Holm is editor of Holm Mortgage Finance Report, Milwaukee

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