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Our Nation's Housing

A farewell to ARMs?

By KENNETH R. HARNEY, Special to the Times
Published January 13, 2007

WASHINGTON - So is it finally a farewell to ARMs, the once-ubiquitous adjustable rate mortgages?

You might think so with fixed rate loans priced just slightly above one-year Treasury-indexed adjustables. After all, why bother with an ARM at 5.8 percent - the average contract rate at the end of December, according to the Mortgage Bankers Association of America - when you could get a 15-year fixed rate loan at 5.9 percent or 30-year fixed rate money at 6.2 percent, all with roughly the same origination fees?

The latest national statistical survey bears this out: New adjustables dropped to a 25 percent share of the total market late last year, according to mortgage investor Freddie Mac's annual ARM survey, down from a 33 percent share as recently as 2004.

Adjustables, which were introduced in the United States in the early 1980s, once ruled the home loan roost. In 1984, they accounted for nearly two of every three new mortgages. Of course, those were the bad, bad old days of hyperinflation, when fixed rate loans went for 15 percent and up and one-year ARMs in the low double digits looked like a relative bargain.

The type of adjustable that dominated during the mid 1980s no longer is a major factor, even within the diminished ARM slice of the market itself. Half of all lenders who offer adjustable rate loans no longer even include one-year, Treasury-indexed ARMs on their menu anywhere, the lowest proportion in 23 years. Now the top adjustables are all hybrids, essentially 30-year loans that come with a fixed rate for the first three, five or seven years. After the fixed rate period is over, the loan morphs into a one-year adjustable that floats with market rates, up or down.

Many hybrids never get past the rate reset date, however. They are often refinanced into a replacement mortgage or simply paid off. Forty percent of all adjustables in the 2006 survey were "5/1" hybrids, according to Freddie Mac, with an average initial rate of 5.96 percent fixed for the first five years. That rate was just 0.5 percent higher than the average floating one-year ARM rate in the survey. By the first week in January, the 5/1 hybrid went for an average 6.02 percent, compared with 6.2 percent for 30-year fixed rate conventional mortgages.

Frank Nothaft, chief economist for Freddie Mac, says the 5/1 adjustable not only offers a slightly lower cost compared with competing 30-year fixed rate loans, but also locks in monthly payments for the first 60 months, a big plus for people who expect to sell, move or refinance within a few years.

But Nothaft warns that there is a potential downside to 5/1 hybrids that fixed rate 15-year and 30-year mortgages avoid: If you don't actually sell or refinance a hybrid by the date it converts into a one-year adjustable, and rates in the global capital markets have risen sharply, you could be hit with an increase of up to 5 percentage points at the reset date.

ARMs may be declining in overall market share, but they're still hot products in some parts of the country, as well as in the subprime mortgage segment, where borrowers have impaired credit and below-par FICO scores. New research by the Mortgage Bankers Association of America found that adjustables accounted for 59 percent of subprime loan originations as of mid 2006.

ARMs also are exceptionally popular in Nevada, where they accounted for an estimated 42 percent of the market last year, and in California 38 percent, the District of Columbia (about 35 percent) and Colorado, Arizona and Florida, where roughly one of every three new mortgages was an adjustable. They were much less popular in Texas and New Mexico (15 percent) and barely 10 percent of the market in South Dakota.

In a number of high-cost areas, many of the ARMs originated in 2004 and 2005 carried "payment option" features that allowed borrowers to make minimal monthly payments, interest-only payments or fully-amortizing payments, at their own choice. Those types of ARMs are now declining in popularity, however, because of greater federal and state regulatory oversight and tougher underwriting standards.

Still, ARMs are not going away entirely. Maybe you can wave farewell to a lot of the old-fashioned one-year adjustables - at least under current interest rate conditions - but not to the newer, hybrid models that still make sense for large numbers of buyers and refinancers.

Oversee the progress

- Take photographs or a video with an audio description of the entire process. Each night after the workers leave, document every surface that was worked on. The photos or videos could come in handy in the future if you need to see what is behind a finished surface.

- Make sure your remodeling contractor does not fidget with utilities on a Friday. You don't want a plumbing or gas leak to pop up after the workers leave for the weekend. Know how to shut off all utilities in your home.

- Don't make the final payment on the job until all work is complete and you are 100 percent satisfied. Never work from oral promises. Your money is the only leverage you have. You must have enough to complete the job if your contractor disappears or you fire him.

[Last modified January 12, 2007, 09:13:12]