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Adjustable-Rate Loans Gain in Popularity

By Kathleen M. Howley
Bloomberg
Saturday, January 8, 2005; Page F12

The portion of U.S. homebuyers opting for adjustable-rate mortgages nearly doubled in 2004, as surging home prices spurred more people to borrow at lower interest rates with shorter fixed periods.

The market share of purchase loans with adjustable rates rose to 34 percent, from 19 percent in 2003, Freddie Mac reported this week.

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It was the highest annual percentage since 1994, when the rate was 39 percent, the McLean mortgage financier said.

While the shift to adustable-rate mortgages (ARMs) has buoyed the housing market by enabling people to borrow at initially lower rates, it leaves consumers vulnerable to a rapid rise in rates once the introductory period is over, said Susan M. Wachter, a professor of real estate at the University of Pennsylvania.

"This is an early warning sign of potential dangers to come," Wachter said. "The surge in ARMs opens a larger percentage of the population to vulnerability to short-term rate increases."

ARMs are at a higher risk of foreclosure, when lenders seize homes after owners fall behind in mortgage payments. The portion of "prime" ARMs in foreclosure, lent to the most credit-worthy borrowers, was 0.57 percent in the third quarter, compared with 0.42 percent for prime fixed-rate loans, according to the Mortgage Bankers Association in Washington.

The average U.S. rate for a one-year ARM probably will advance to 4.65 percent this year, from 3.9 in 2004, Fannie Mae said. The average fixed rate likely will be 6.01 percent in 2005, compared with 5.85 percent last year, the second lowest in 38 years.

Two of every five ARMs in 2004 were 5/1 hybrids -- loans that have a rate fixed for five years, then revert to a traditional one-year adjustable mortgage, according to Frank Nothaft, Freddie Mac's chief economist.

Because the loans have become so popular, the mortgage company will begin reporting average rates for the product in its weekly mortgage survey beginning this week, he said.

The highest ARMs market share was in 1984, the first year of the survey, when the proportion was 62 percent, Nothaft said.

U.S. home prices climbed 13 percent year-over-year in the third quarter, the fastest pace in 25 years, according to the Office of Federal Housing Enterprise Oversight.

In the past 20 years, annual gains have averaged 4.5 percent, according to the National Association of Realtors.


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