Freddie Mac Release: Economic Conditions Lead to Less Desirable Adjustable Rate Mortgages in 2000 Spreads Between Fixed-Rate Mortgages and Adjustable-Rates Fall To Record Lows
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McLean, VA – Adjustable-rate mortgages (ARMs) lost their luster in 2000, as the economy slowed and interest rates shifted. The Federal Reserve Board (Fed) continued its fight against the threat of inflation, aggressively raising rates by a full percentage point in the first half of the year. The U.S. Treasury Department issued fewer securities and began repurchasing their longer-term debt, thus greatly reducing the supply of Treasury securities that serve as a benchmark for other interest rates. As a result, the yield curve inverted, effectively making long-term debt less expensive than shorter-term debt.
"According to Freddie Mac's 17th Annual ARM Survey, the interest-rate advantage between ARMs and fixed-rate mortgages (FRMs) fell to a record 0.37 percentage points for the traditional one-year ARM," said Frank Nothaft, deputy chief economist for Freddie Mac. "Consequently, the ARM share fell to 16 percent in November, compared to 29 percent at the same time last year, according to industry sources."
Yield Curve Inversion
The Fed began to raise rates in 1999 in response to a rapidly growing economy. Such a strong economy can lead to inflation, especially during times of full employment, strong income growth, and dynamic consumer spending. It continued to raise rates in the first half of 2000. By May, the average rate on a 30-year FRM peaked at 8.64 percent over fears of impending inflation. ARM rates also rose in sync with the Fed's actions, but were still about 1.5 percent below FRMs. That kept the ARM share of the market fairly constant at about 30 percent.
At about the same time, the Treasury Department began aggressively repurchasing their long-term debt, effectively reducing the available supply further. Investors had to pay a premium for these securities that lowered their yields.
"Inflation concerns began to ease in the second half of the year," explained Nothaft. "The markets felt that the Federal Reserve had done enough to curb the threat of inflation. New leading indicators began to suggest the economy was slowing, and there was even talk of an upcoming recession in the new year. As a result, interest rates for FRMs fell over 1.7 percentage points, while short-term rates remained close to their high levels as targeted by the Fed."
The Federal Reserve recently lowered the overnight lending rate by half of a percentage point on January 3, 2000. The markets responded aggressively, with short-term interest rates falling dramatically. Looking ahead, ARM rates should also fall relative to FRMs and become a more affordable mortgage option.
Annual Survey Results
The interest rate difference between FRMs and ARMs amounted to 0.37 percentage points over the week-ending December 15th, the narrowest since Freddie Mac started to collect ARM quotes in 1984. Because homebuyers are showing little interest in ARMs, a few lenders stopped even quoting these rates. Only about 93 percent of the lenders offered the traditional 1-year conforming ARM, down from 96 percent in 1999. Even the initial discount that lenders will give to homebuyers for the first year fell from 1.99 in 1999 to 1.46 percentage points in 2000. The share of lenders offering jumbo and government-insured ARMs remained about the same in 2000.
Jumbo mortgage rates in general were greatly affected by the economic uncertainty. The interest rate difference between jumbo ARMs and conforming ARMs was 0.36 percentage points, the largest spread since Freddie Mac began collecting the data. Jumbo mortgages tend to be more sensitive to the economy because Freddie Mac and Fannie Mae cannot purchase them. "Freddie Mac and Fannie Mae lower interest rates on both FRMs and ARMs in the conforming market. Consumer save over $15 billion in interest payments each year as a result," explained Nothaft.
For almost a quarter of a percent in the mortgage rate, homebuyers could extend the initial reset period to three years or a little more for five years. Homebuyers have been using this extended-term option more often recently. In fact, the 5/1 ARM has now become the most popular ARM product in the second quarter of this year, according to the Federal Housing Finance Board. "Historically," commented Michael Schoenbeck, senior financial analyst, "the traditional 1-Year ARM dominated the ARM market with nearly a third of all ARMs originated."
With the yield curve inverted, a few lenders actually had interest rates for longer initial-period ARMs lower than the traditional 1-year ARM. Another factor with an inverted yield curve is that the interest rates for medium-term hybrid ARMs -- 7/1 ARM, 10/1 ARM -- are equal to or above the 30-year FRMs.
Various ARM Product Features in 2000
|1-Year ARMs||3-Year ARMs||Longer Initial-Period ARMs|
|1/1 Conforming||1/1 Jumbo||1/1 FHA||3/1||3/3||5/1||7/1||10/1|
-- -- -- -- -- P e r c e n t a g e P o i n t s -- -- -- -- --
|Initial Interest Rate||7.05||7.41||7.21||7.27||7.40||7.29||7.42||7.58|
|Fees and Points||1.0||0.9||0.9||0.9||0.9||0.9||0.9||0.9|
|Fixed-Adjustable Rate Spread||0.37||0.5||0.37||0.15||0.02||0.13||0.00||-0.16|
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 98 ARM lenders during the week ending December 15, 2000. 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 15, 2000. The rate spread is based on the average 30-year conforming fixed-rate mortgage (FRM) commitment rate of 7.42 percent from Freddie Mac’s Primary Mortgage Market Survey for the week ending December 15, 2000, and the average 30-year Jumbo FRM and average 30-year FHA FRM commitment rates of 7.91 percent and 7.58 percent, respectively, as reported by BanxQuote for the week ending December 15, 2000.
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.