Freddie Mac Says Hybrid ARMs most Popular of an Unpopular Product

Freddie Mac said today that initial rates on adjustable rate mortgages (ARMs) are at the lowest recorded levels in the 29 year history of its ARM Survey.  The most recent edition of that survey was conducted from January 7 to 10 and also showed the hybrid ARMs remain the most common of the adjustable rate products available in the market.

Over the last several years the Weekly Mortgage Application Survey conducted by the Mortgage Bankers Association has consistently pegged the market share of ARMs at 3 to 4 percent.  Freddie Mac says that hybrid ARMS, those adjustable rate mortgages with an extended initial fixed-rate period of three, five, seven, or ten years after which they adjust annually, are the most popular loan product among ARMs.  The 5/1 hybrid is the most common, offered by 90 percent of lenders surveyed.  Second is the 3/1, offered by 68 percent.  Least popular is the 3/3 where the rate adjusts every three years for the life of the loan.

At the time of the survey the interest rate savings for the 5/1 hybrid ARM with a 30-year term compared to the 30-year fixed-rate mortgage (FRM) was about 0.65 percentage points or about $90 less in the first five years of a $250,000 loan.   Freddie Mac credits the Federal Reserve's accommodative monetary policy with keeping short-term interest rates very low and, over the past year, helping to lower longer term rates.

Compared with last year, the largest declines in initial interest rates among hybrid products occurred with the 7/1 and 10/1 hybrids. For these products with long initial fixed-rate periods, rates declined by 0.32 and 0.57 percentage points, respectively.  Again this reflects the effects of the Federal Reserve's latest round of quantitative easing.

Among the 131 ARM lenders surveyed, 69 percent offered loans tied to Treasury yields, up from 65 percent in 2012; the remaining offered products tied to the London Interbank Offered Rate (LIBOR). LIBOR-indexed ARMs generally had a lower margin (about 0.5 percentage points lower) than Treasury-indexed ARMs, a similar initial interest rate, but a higher fully indexed rate. The higher fully indexed rate reflects the fact that one-year LIBOR yields averaged 0.7 percentage points above one-year Treasury yields in early January.

Frank Nothaft, Freddie Mac's vice president and chief economist, said of the survey results, "Homebuyers have shied away from ARMs, particularly 1-year ARMs, because they are wary of the risk and uncertainty. The potential for much larger payments if, interest rates are significantly higher in the future, and the high delinquency rates borrowers have experienced on ARMs in recent years, have led consumers to prefer fixed-rate loans instead of ARMs. In addition, fixed-rate loans currently carry rates near historic lows, and only a small amount above initial rates on ARMs.

"Borrowers who have taken out ARMs generally prefer hybrids, because these products include an extended initial period where the interest rate is fixed. During 2012, ARMs comprised one-in-ten new home-purchase loans, according to the Federal Housing Finance Agency. We are expecting ARMs to gradually gain back some favor with mortgage borrowers, with the ARM share rising to 12 percent of the home-purchase market in 2013."