This ARM is broken. A complex-compound fracture. If it was a thoroughbred, it would be put out of its misery.
Borrowers looking for a good, low introductory rate home loan, usually couched in a one-year adjustable-rate mortgage, known as an ARM, are going to find themselves in for a rude awakening.
The one-year ARM, the darling of loan officers during times of higher fixed-rate mortgages, just isn't what it used to be.
Case in point: Last week, Wells Fargo Home Mortgage was offering a no-points, 30-year, fixed-rate mortgage at 8.125 percent. The one-year ARM, which historically carries a lower rate because of its volatility, was being offered -- also with no points -- at 8.375 percent.
The answer lies primarily at the feet of Federal Reserve Board Chairman Alan Greenspan. Because of the series of increases in short-term interest rates in the past 12 months by the Federal Reserve Board, the spread between adjustable-rate and fixed-rate mortgages is hovering at its narrowest point ever.
The most recent Freddie Mac weekly mortgage survey shows an 0.89 percentage point difference between its 30-year, fixed-rate average, which stood at 8.21 percent, and its one-year ARM at 7.32 percent. On July 13, the spread reached its lowest at 0.87 percentage point. Compare that to April 1994, when the spread reached 3.51 percent -- the widest of the decade -- and when a one-year adjustable mortgage was under 5 percent.
Even the spread between the 30-year traditional fixed-rate mortgage and hybrids such as the five-year and the seven-year ARMs -- that give borrowers a period of stability before adjusting annually -- was virtually nonexistent. At Wells Fargo, a no-points "5/1" ARM on Thursday was 8.125 percent, and its "7/1" ARM stood at 8.25 percent.
"In the more than 16 years that we have been doing our survey, we've never seen that difference so small," said Frank Nothaft, deputy chief economist for Freddie Mac, the federally chartered mortgage giant that supplies funds to lenders by purchasing mortgages. "It is really remarkable.
"If you look at our survey rates over the past year, you will see ARM rates are up about 1.25 percent, which is about the same amount that the Fed has increased short-term interest rates over that period. And if you look at fixed-rate mortgage rates, they are up too, but maybe only about a half of a percentage point. That is because the Fed doesn't directly control the pricing of fixed-rate loans."
The actions by the Fed have caused the bond market, which influences how mortgages are priced, to invert. Simply, short-term bonds, which typically have a lower percentage rate than long-term bonds, are now doing the opposite. The one-year ARM uses the 52-week Treasury bill, which stands at 6.09 percent, as its index. The 30-year treasury bond, which should give investors a higher yield because it ties up money longer, was at 5.80 percent.
"Go figure," said Tom Champion, manager of the Lutherville, Md., office of Wells Fargo Home Mortgage. "What I've seen over my last 12 years in this business is, little by little, the spread between the one-year ARM and the 30-year (fixed rate) decrease. Never have I seen it invert."
What this means in real dollars is that using a one-year ARM today at 7.32 percent -- the Freddie Mac average Thursday -- the principal and interest is $1,030 for a $150,000 loan. A year ago, the one-year ARM was 5.97 percent, meaning the same loan would cost $896 a month, for a savings of $1,608 in the first year before adjusting.
And when weighing whether to choose the stability of a 30-year fixed-rate mortgage that is priced less than a percentage point higher than the annually adjusting one-year ARM, the choice for most consumers is obvious.
"What you have today is a one-year ARM that is virtually useless," said Keith Gumbinger, vice president of HSH Associates, a New Jersey-based company that tracks and analyzes mortgage rates.
Said Nothaft: "You'll save a little money on the interest the first year, but a year from now it is quite likely the adjustable-rate loan will adjust a full 2 percentage points and you'll be paying 1 1/8 percentage points more than if you would have taken out that fixed-rate loan today.
"That is why we have seen the ARM share running so low in the marketplace today. Normally, when fixed rates go up like we've seen them go up over the last year, we would see more families move into the adjustable-rate product. But we haven't seen that. In fact, we've seen a decline in the ARM share over the last few months, and that is because that differential has come down," said Nothaft, noting that ARMs make up less than 20 percent of all mortgage originations.
Although the Fed might be the primary culprit, it is not alone in the downfall of the ARM, according to Gumbinger. He notes the Fed's moves as well as the disappearance of thrifts that would offer below-market teaser rates, mergers within the banking industry that have eliminated competition, regulations by Freddie Mac and Fannie Mae and even consumers themselves.
"(Thrifts) used to go cut each other's throats in order to get you in the door," Gumbinger said. "The difference today is that there are fewer thrifts -- mergers and acquisitions being what they are -- that would write these (ARMs) for their own portfolio. But also Freddie and Fannie now (have more influence) now than they did back then."
Gumbinger said that if a lender wanted Freddie Mac and Fannie Mae to buy the loan, it has to "dance to whatever their tune is." Therefore, a lender couldn't discount an ARM product for a lower rate than what was dictated by the formula used by two quasi-governmental companies.
"If we get a resurgent inflation picture, 30-year rates will climb," Gumbinger said. "If we get no change to the inflation picture, we will be stuck in this stagnant mortgage (position) that we are in right now with no product to really shine through as an outstanding deal.
"If inflation begins to decline, and that starts (the Fed) cutting rates, the gap for ARMs will start to widen again."
Distributed by the Los Angeles Times-Washington Post News Service
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