An abrupt shift in consumer preference has pushed demand for adjustable-rate mortgages to a five-year high.

Home loans carrying adjustable rates accounted for nearly 36% of all mortgages written in May - the highest level since June 1989. according to the Federal Housing Finance Board.

The loans' share of the market was up from 31% in April and just 23% in March. The average for last year, during the refinancing boom, was about 20%.

With interest rates rising, consumers have been drawn to adjustables due to their relatively low starting rate. Last week, lenders offered one-year adjustables at an average of 5.45%, versus 8.65% for 30-year fixed-rate loans, according to Butler, N.J.-based HSH Associates.

Unexpected Surge

David Lereah, chief economist for the Mortgage Bankers Association, said the gain for May was larger than he had expected and attributed it to below-market introductory rates that are being offered by many banks and thrifts.

The big thrifts have been especially aggressive in marketing adjustables in recent months, triggering intensive price competition and sending their volume skyward.

A spokeswoman for Home Savings Bank, Irwindale, Calif., said 98% of its originations were adjustables in May, up from 93% in April and 86% in March.

But as the federal data show, mortgage banks haven't been sitting on the sidelines. Adjustables accounted for 21% of mortgage companies' originations in May, up from 11% in April.

"The secondary market for ARMs is much more developed now than it was the last time adjustables were popular," said Mr. Lereah. "That gives the mortgage banks the opportunity to originate more ARMs to meet demand."

PNC Mortgage Corp., one of the largest bank-owned mortgage companies,said adjustables account for about 30% of its business. It has been selling some to thrifts and placing some with its parent, PNC Bank.

Because of the rate competition, profit margins for originations of adjustables have almost disappeared, experts say.

Lenders that hold mortgages in their portfolios don't mind because they will profit from collecting interest over time. But mortgage banks don't have this advantage. As a result, they have been scrambling to form alliances with thrifts that would buy their adjustable-rate production.

In its most recent report, the Federal National Mortgage Association said just 5.2% of the loans it financed carried adjustable rates.

Bowing to the demand, Fannie Mac stepped up its ARMs program last week by adding a new model and is now offering to buy ARMs starting with fixed periods of three, five, seven, and 10 years as standard loans. Both Fannie Mae and the Federal Home Loan MortgageCorp. have been buying threes, fives, and sevens on a negotiated basis.

Fannie also added a six-month adjustable pegged to the London interbank offered rate.

Observers generally agree that interest rates will determine how long the shift to adjustable-rate mortgages persists. "If rates rise, I would expect to see ARMs account for 40% of all mortgages next year," said the MBA's Mr. Lereah.

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