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Freddie Mac Releases Results of Its 21st Annual ARM Survey

Larger Initial Rate Discounts and Increased Popularity of Hybrids

For Immediate Release

January 05, 2005
or (703) 903-3933


McLean, VA – Freddie Mac today released the results of its 21st Annual Adjustable-Rate Mortgage (ARM) Survey, which found:

  • Greater lender discounts for introductory ARM rates;
  • Smaller interest-payment savings for ARMs relative to fixed-rate loans;
  • Increasing popularity of hybrid ARMs relative to one-year adjustables.

"The Federal Reserve ratcheted up short-term interest rates five times over the last half of 2004, raising their Federal Funds target from 1.0 percent to 2.25 percent," said Frank Nothaft, Freddie Mac vice president and chief economist. "Long-term mortgage rates were little affected, averaging about the same at the end of the year as they did in the beginning. Initial rates on ARMs, however, rose by about 40 basis points over the course of the year because they typically are priced off of financial instruments with shorter maturities that match the length of the initial adjustment period."

The survey, based on data collected December 20 to December 23, found that starting rates for ARMs would have increased even further were it not for greater use of initial-rate discounts by lenders. In order to encourage homeowners to opt for an ARM, lenders typically offer a lower initial interest rate than what the fully-adjusted rate would be at the time of origination, i.e., the underlying index rate plus the margin. At the beginning of 2004, this discount amounted to about three-eighths of a percentage point for conventional, conforming one-year Treasury-indexed ARMs and by the end of the year it had increased by almost a full percentage point, to an average of 1.34 percentage points. Over the last 21 years, initial one-year discounts averaged about 1.7 percentage points.

"When the interest-rate difference between a 30-year fixed-rate mortgage and the fully-indexed ARM rate decreases, lenders generally offer a larger initial rate discount on the ARM," observed Nothaft. "The larger initial discounts increase the initial rate benefit of an ARM compared with fixed-rate loans, helping lenders to maintain ARM originations."

2004 started off with a steep Treasury yield curve, where the rate spread between 10-year and 1-year constant-maturity yields was 2.91 percentage points, yet ended the year around 1.57 percentage points. During periods of a steep yield curve, ARMs become more popular among consumers.

"For instance, in 2004 the ARM share of mortgage originations peaked in June at 40 percent of conventional home-purchase loan activity," added Nothaft, who referenced Federal Housing Finance Board (FHFB) data. "This followed a 2.94 percentage point high for the year in the 10-year to 1-year Treasury rate spread in May."

Through November, ARMs accounted for 34 percent of the conventional purchase-money market in 2004. This marks the highest annual share since 1994 when the ARM share was 39 percent. The highest annual ARM share occurred in 1984 at 62 percent, the same year Freddie Mac began its Annual ARM Survey.

Compared with Freddie Mac's previous Annual ARM survey, the interest rate savings on ARMs is now smaller, even with the initial rate discounts that are offered by lenders. For example, the one-year adjustable carried a rate that was 2.0 percentage points below a 30-year fixed-rate loan in the last survey, but only 1.6 percentage points lower in the current survey, reflecting the rise in short-term interest rates over the last several months.

Over the last several years, annually adjusting ARMs with an initial "fixed-rate" period of more than one year, known as "hybrid" ARMs, have grown in popularity. According to the FHFB data, hybrid ARMs accounted for the majority of purchase-money ARMs by 2002. Within that product type, ARMs with an initial fixed-rate period of five years, known as "5/1" ARMs, have been the dominant choice of consumers. "In 2004, two-of-five ARMs, and three-of-five hybrids, were 5/1 ARMs," commented Nothaft. "Starting this week, Freddie Mac has begun collecting 5/1 hybrid ARM data in our weekly Primary Mortgage Market Survey, and will begin releasing the data this month. This will provide families with additional information on the interest rates and fees associated with 5/1 hybrids, to help them as they compare costs of different loan types," he added.

The average initial interest rate on 5/1 hybrid ARMs was 4.99 percent in the 21st Annual ARM Survey, or 0.82 percentage points above the rate on the traditional 1-year adjustable, and 0.65 percentage points below the rate on a 30-year fixed-rate mortgage. "Hybrid ARMs provide the consumer the comfort of knowing that the interest rate will be fixed over the first five years of the loan. However, the interest rate may jump as much as five percentage points on the fifth anniversary. Thus, the product has been popular with families who plan to have the mortgage for five years or less," Nothaft observed.

In general, ARM rates are lower than the traditional 30-year FRMs owing to the homeowner exposure to the inherent interest-rate risks of periodic adjustments. For hybrid ARMs, rates are higher than 1-year ARMs. However, once the first rate-adjustment occurs, subsequent annual rate adjustments are virtually the same, owing to similar margins across these loan options. The biggest difference depends on the course of future 1-year Treasury rates and the embedded interest rate caps. But if interest rates remain relatively stable, then all of these ARMs will ultimately converge to the same interest rate over time.

In all, potential homebuyers and existing homeowners opting for a Treasury-indexed ARM amortized over 30 years with a loan amount of about $175,000 can expect initial savings (up until the first rate adjustment) over a FRM of up to:

  • About $2,022 for one-year conforming ARMs;
  • Around $6,510 for one-year jumbo ARMs (assuming an average loan amount of $515,000);
  • Roughly $2,245 for ARMs insured by the Federal Housing Administration (FHA);
  • Almost $4,544 for 3/1 ARMs (wherein the first rate-adjustment occurs in three years and then adjusts on an annual basis);
  • About $3,329 for 3/3 ARMs (wherein the mortgage rate adjusts every three years);
  • Nearly $4,973 for 5/1 ARMs (wherein the first rate adjustment occurs in five years and then adjusts on an annual basis);
  • Around $3,881 for a 7/1 ARM (wherein the first rate adjustment occurs in seven years and then adjusts on an annual basis);
  • And almost $4,498 for 10/1 ARMs (wherein the first rate adjustment occurs in ten years and then adjusts on an annual basis).
  1-Year ARMs 3-Year ARMs Longer Initial-Period ARMs





Loan Terms -- -- -- P e r c e n t a g e P o i n t s -- -- --
Underlying Index Rate 2.71 2.71 2.71 2.71 3.22 2.71 2.71 2.71
Margin 2.80 2.81 2.71 2.76 2.78 2.76 2.76 2.77
Fully-Indexed Rate 5.51 5.52 5.42 5.47 6 5.47 5.47 5.48
Initial Year’s Discount 1.34 1.33 1.29 0.89 1.1 0.48 0.14 0.07
Initial Interest Rate 4.17 4.19 4.13 4.58 4.9 4.99 5.33 5.41
Fees and Points 0.6 0.7 0.8 0.4 0.6 0.4 0.5 0.7
Fixed-Adjustable Rate Spread 1.58 1.72 1.75 1.17 0.85 0.76 0.42 0.34
Product Concentration (%) 75 59 36 70 13 72 46 21


Notes: The sample is limited to ARMs indexed to either the 1-year or the 3-year constant maturity Treasury (CMT) yields. Data were collected from 100 ARM lenders from December 20 to December 23, 2004. 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 comparable week ending December 22, 2004. The conventional, conforming rate spreads are based on the average 30-year conforming fixed-rate mortgage (FRM) commitment rate of 5.64 percent from Freddie Mac’s Primary Mortgage Market Survey for the week ending December 22, 2004. The average 30-year Jumbo FRM rate is based on 5.91 percent as reported by for December 22, 2004. The average 30-year FHA FRM rate spread is based on the contract rate of 5.88 percent as reported by the Mortgage Bankers Association’s applications survey for the week ending December 24, 2004."

Freddie Mac is a stockholder-owned corporation established by Congress in 1970 to create a continuous flow of funds to mortgage lenders in support of homeownership and rental housing. Freddie Mac purchases mortgages from lenders and packages them into securities that are sold to investors. Over the years, Freddie Mac has made home possible for one in six homebuyers in America.

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