With Fixed Rates This Low, Who Needs ARMs?

Adjustable-rate mortgages — or ARMs — used to be a popular product for refinancing: A borrower paying a high rate would trade in the remainder of a long-term fixed-rate mortgage for an ARM with a low introductory rate. But with the Federal Reserve having slashed its federal funds rate — the target rate for overnight bank lending — by more than four percentage points over 2008 to a range of zero to 0.25 percent and interest rates on 30-year fixed-rate mortgages effectively averaging 5.1 percent last week, refi options have migrated away from ARMs, according to the results of Freddie Mac‘s (FRE) 25th annual ARM survey. ARM applications accounted for only 3 percent of application volume in December, “the lowest recorded in our survey,” compared with 2004 and 2005 peaks near 36 percent, according to Freddie’s vice president and chief economist, Frank Nothaft. Of conventional, prime borrowers originally under a one-year ARM that refinanced in the third quarter of 2008, 94 percent refinanced into a conforming fixed-rate loan. About 82 percent of borrowers originally under hybrid ARMs refinanced into fixed-rate mortgages, according to Freddie’s survey. The data, released Friday, show large premiums for initial interest rates on Treasury-indexed ARMs, a “very thin market” for one-year, Treasury-indexed ARMs, and a continued decline in ARM share of overall lending as the typical starting interest-rate savings relative to fixed-term loans evaporated, according to Freddie. “Our survey found that starting rates for conforming one-year ARMs averaged 1.76 percentage points above their fully-indexed rate, the largest rate premium observed since Freddie Mac began collecting ARM data in 1984,” Nothaft said. “Further, rates on 30-year fixed-rate mortgages had fallen to 50-year lows and were near or below initial rates on ARM products.” These low fixed rates sparked an exodus to 30-year fixed rate mortgages as refinance products. “Mortgage rates for conventional conforming 30-year fixed-rate loans fell to a new record low in the final weeks of the fourth quarter of 2008, giving borrowers an opportunity to save quite a bit on their monthly payment,” Nothaft said. “When interest rates fall sharply we tend to see more borrowers go for a simple rate-and-term refi that lowers their payment or lets them keep their payment about the same but shorten the maturity of their mortgage obligation.” In the fourth quarter of 2008, borrowers cashed out $17.5 billion in home equity by refinancing — the lowest amount since the first quarter 2001, according to Freddie’s quarterly refi review, released Friday. In another indicator of how homeowners are using their refis, Freddie saw 14 percent of refinancing borrowers pay in additional money at the time of refi, reducing mortgage debt and suggesting consumers are moving toward debt-reducing habits and away from debt-building habits apparent in cash-out refis. “Borrowers who have owned their home for many years often have substantial equity in their homes,” Nothaft said. “We found that, on average, borrowers who refinanced were replacing a mortgage that was 3.6 years old and over the time they had that mortgage their home value was up by 9 percent. In the fourth quarter of 2008, homeowners who refinanced lowered their coupon rate by one-quarter of a percentage point based on the refinance report’s median ratio of new-to-old interest rate.” Write to Diana Golobay at diana.golobay@housingwire.com. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.