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Historically Low Fixed-Rate Mortgage Rates Keep Market Share Of ARMs Low

Homebuyers Continue To Opt For Stability Of Low Fixed-Rates

For Immediate Release

December 23, 2002
Contact: corprel@freddiemac.com
or (703) 903-3933

 

McLean, VA – Freddie Mac released the results of its 19th annual survey of Adjustable Rate Mortgages (ARMs) today, which noted that at the end of 2002, 30-year fixed mortgage rates had fallen to their lowest levels in more than a generation, spurring a wave of home purchases and refinancing activity. Although the most popular choice of mortgage loan among households remains the 30-year fixed-rate mortgage (FRM), where homeowners can secure a fixed, monthly payment over the life of the loan, ARMs accounted for an estimated 17 percent of new mortgage loans originated in 2002, up from 12 percent in 2001..

"Historically, ARMs carry lower initial interest rates compared to fixed-rate loans because the interest rate can adjust," commented Frank Nothaft, Freddie Mac chief economist. "The most common ARM is indexed to the one-year Treasury yield, i.e., the mortgage rate adjusts at its reset anniversary based on changes in the one-year Treasury yield, subject to any cap on the amount of the interest rate or monthly payment change. But despite a historic low in 1-year ARM rates, this mortgage was not very popular among mortgage shoppers this year, due to the uncertainty of annual adjustments to their monthly payments and the 37-year low in fixed-rate mortgage rates." During the week ending December 20, 2002, the average initial interest-rate on a 1-year ARM was 4.07 percent, the lowest recorded since 1981, when ARMs first became prevalent across the U.S.

To entice mortgage applicants to apply for ARMs, lenders may discount the initial interest from the fully indexed rate. This is commonly known as "teaser pricing." Such teaser discounts were as high as 3 percent over the last ten years. In the last couple of years, however, short-term rates have fallen so low that lenders have largely abandoned such introductory pricing and, in some cases, now charge a premium, in order to protect their balance sheets against rising interest rates and periodic interest rate caps.

"In truth, teaser pricing did boost ARM borrowing over select years, especially when fixed-rate mortgage rates were high, but currently they are a smaller factor in household financing decisions," added Nothaft.

"According to Freddie Mac's Annual ARM survey, a family can shave almost two percentage points off their mortgage rate with a conventional conforming one-year ARM. This translates into a saving of over $2,900 during the first year in monthly mortgage payments, compared to a 30-year fixed-rate mortgage, based on an average home-purchase loan of $200,000. Approximately 79 percent of ARM lenders offer such an option," said Nothaft.

Another category of ARMs, called hybrid ARMs, extend the initial reset period up to ten years, allowing homeowners additional time to reconcile monthly payment adjustments with expected increases in income or changes in living environments. These interest rates tend to be higher than traditional 1-year ARMs, but usually fall below those of fixed-rate mortgages. Over the last decade, the hybrid ARMs have become more popular.

The most widely offered hybrid ARM was a 3/1 ARM which can save a family nearly $2,400 in monthly payments for the first year, and almost $7,200 for the initial three years of the loan. A "3/1" hybrid has an initial interest rate that remains fixed for three years, but then adjusts annually after that. About three-quarters of ARM lenders offer a 3/1 ARM.

Second on the list was a 5/1 ARM, which offers an initial year reduction of over $1,500 in mortgage payments, but can ease a family's debt burden by about $7,700 over the initial five years. Seventy five percent of lenders are willing extend this type of mortgage.

"The 3/1 ARM and 5/1 ARM have become increasingly popular in the market because they offer consumers an attractive blend of the lower initial rate benefit of an ARM with the benefit of a fixed-interest obligation, albeit only for a few years. Families who plan to be in their homes for three to five years may find these loans beneficial compared to a 30-year fixed-rate loan. Why pay the higher cost for thirty years of protection against interest rate shocks, when you will have the loan for no more than five years?" commented Nothaft.

The third most popular hybrid ARM is the 7/1 ARM, available among nearly half of ARM lenders, which can save homeowners around $920 for the first year and $4,500 for the seven-year period.

Given today's historic low interest rates, only 20 percent of lenders in the sample were willing to extend 10/1 ARMs, which have the potential to save homeowners approximately $1,700 over the first ten years of the loan.

Some lenders - about 28 percent of those surveyed - offer a 3/3 ARM. A 3/3 ARM has an interest rate adjustment every third year. "The first year savings in mortgage payments totals only about $125, but depending on the path of future interest rates, it can have more payment stability than the annually adjusting hybrids," observed Michael Schoenbeck, Senior Financial Analyst for Freddie Mac.

Freddie Mac conducted its 19th annual ARM survey over the week ending December 6, and the results are presented below in Table 1.

Various ARM Product Features in 2002

 
1-Year ARMs
3-Year ARMs
Longer Initial-Period ARMs
 
Conforming
Jumbo
FHA
3/1
3/3
5/1
7/1
10/1
Loan Terms
-- -- -- -- -- P e r c e n t a g e P o i n t s -- -- -- -- --
Index Rate
1.53
1.53
1.53
1.53
2.44
1.53
1.53
1.53
Margin
2.77
2.75
2.71
2.78
2.77
2.80
2.78
2.76
Fully-Indexed Rate
4.30
4.28
4.24
4.31
5.21
4.33
4.31
4.29
Initial Discount
0.09
-0.07
-0.46
-0.28
0.03
-0.84
-1.28
-1.79
Initial Interest Rate 4.21 4.35 4.70 4.59 5.18 5.17 5.59 6.08
Fees and Points
0.6
0.6
0.5
0.5
0.4
0.5
0.5
0.4
Fixed-Adjustable Rate Spread
1.98
2.15
1.49
1.60
1.01
1.02
0.60
0.11
Percent of ARM Lenders Offering Product
79
76
54
76
28
75
51
20

Notes: The sample is limited to ARMs indexed to either the 1-year or the 3-year constant maturity Treasury (CMT) yield. Data were collected from 107 ARM lenders during the week ending December 6, 2002. The 3-year, 5-year, 7-year and 10-year ARM results are limited to conforming loans. The initial discount is based on the value of the weekly average 1-year or 3-year CMT yield for the week ending December 6, 2002. The conventional, conforming rate spreads are based on the average 30-year conforming fixed-rate mortgage (FRM) commitment rate of 6.19 percent from Freddie Mac's Primary Mortgage Market Survey for the week ending December 6, 2002. The average 30-year Jumbo FRM was estimated at 6.50 percent based on the spread between conforming and jumbo 30-year FRMs as reported in Inside Mortgage Finance for December 6, 2002. The average 30-year FHA FRM rate was 6.19 percent, as reported by BanxQuote for the week ending December 6, 2002.

Freddie Mac is a stockholder-owned corporation established by Congress in 1970 to support homeownership and rental housing. Freddie Mac purchases single-family and multifamily residential mortgages and mortgage-related securities, which it finances primarily by issuing mortgage passthrough securities and debt instruments in the capital markets. Over the years, Freddie Mac has opened doors for one in six homebuyers and more than two million renters in America.

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