Adjustable-rate mortgages are enjoying a return to popularity because of a narrowing gap between short-term and long-term interest rates.
Since January, the offering rate on 30-year fixed-rate loans has climbed by about 115 basis points, while the one-year adjustable rate has increased by only 60 points, according to figures from HSH Associates in Butler, N.J.
The reasons are fairly simple: Inflation fears have pushed the bond market down and long-term yields up. But short-term rates are normally less affected by inflation fears, and the Fed has decided it did not have sufficient reason to intervene in the market.
As a result, homebuyers have what John Lonski, senior economist at Moody's Investors Service in New York, calls "an escape valve." And they have been using it in increasing numbers.
New figures from the Federal Housing Finance Board show that 36% of mortgages written in July carried adjustable rates, a bigger share than at any other point in the past year. A year earlier, less than one-quarter of mortgages were adjustables, and the figure drifted down to just 14% in February 1996.
The favorable spread should continue to support the strong housing market for much of the rest of the year. It should also improve originations volume at thrifts, which specialize in adjustables, at the expense of mortgage banking companies, which focus on fixed-rate loans.
"What we're seeing is that commercial paper is lower than at the start of the year, the Libor rate is unchanged, and companies as well as individuals have the choice of financing at short-term rates," Mr. Lonski said. "Until the Federal Reserve begins to tighten and force money market rates higher, borrowers can avoid the 1996 run-up in long rates."
He added that he doubted that the Fed would tighten this year unless it was forced to do so by a strong selloff in the bond market in response to mounting inflation fears. He also expects the strong housing market to slacken in the next few months. "By the end of 1996," he said, "the year- over-year growth will have disappeared."
The housing market, though, could get a lot of adrenalin if a campaign proposal by President Clinton becomes reality. His plan is to provide a lifetime $500,000 tax exemption for capital gains tax on the sale of a residence.
Such an exemption would likely fuel a housing boom because it would restore a substantial investment incentive to homeownership, something that has been absent for the last decade. It would also allow older homeowners who may be locked into big houses by a potential tax bill to trade down, another stimulant to housing demand.
Strong demand, though, could push home prices up. And the strong housing market could heat up the economy, leading to higher interest rates. The net impact on the mortgage business, while clearly positive, might reduce housing affordability for entry-level households to some extent.
But the Clinton administration is also proposing a significant expansion of the Department of Housing and Urban Development's FHA program by increasing loan limits by about a third. The more lenient up-front terms would likely reduce one of the big barriers to homeownership. But the plan is likely to be highly controversial.
