The revolution in home mortgages is off to a slow start in the Washington area.

Although banks have been making renegotiable balloon mortgages for many years, it is just within the past few weeks that Washington area savings and loan associations and mortgage bankers have begun to offer adjustable rate mortgages (ARM).

The ARM was conceived as a way of helping thrift institutions out of their current financial dilemma.

Unlike a conventional mortgage with its unvarying payments, an ARM has interest rates and monthly payments that go up or down roughly with inflation. (The official name for such a loan issued by a savings and loan is adjustable mortgage loan. For simplicity's sake, both will be referred to here as ARM.)

Yet this creation of high interest rates is also their victim. Few lenders can afford to discount ARMs and fewer borrowers can qualify anyway. In addition, ARMs are very confusing because of their seemingly infinite variations.

Consumer organizations have loudly protested that buying a home with an ARM may be "like the numbers racket." They show that monthly payments on houses bought in 1976 could have almost doubled by 1981 if the ARM had existed then.

Interest Data Reports, published by Peeke & Associates, found only a dozen lenders in the area offering ARMs in mid-August. Interviews with those lenders suggest varied reactions from customers.

C. Jared Hale, president of Unity Mortgage Corp., says: "No one likes ARMs. There are too many programs. Those who are buying them are sophisticated people who think interest rates have peaked. When rates are lower they plan to refinance with fixed-rate loans." Unity's ARM loans amounted to about 2.5 percent of sales last month.

Mortgage bankers note that ARM sales appear to be to upper-bracket buyers who cannot get loans of more than $98,500 elsewhere. (Loans over that amount cannot be sold to the Federal National Mortgage Association or the Federal Home Loan Mortgage Corp., government-chartered secondary market makers.)

Jefferson Federal Savings and Loan finds that most ARMs are being taken out by home owners obliged to refinance. Borrowers are very cautious, observes Stephen Cox, senior vice president of B.F. Saul Co., which offers a 12-year balloon note and accelerated amortization in lieu of decreased monthly payments if interest rates go down. However, John Nevin of First Federal Savings and loan of Arlington finds less resistance than anticipated. And City Mortgage Services reports "wonderful sales, a lot of activity."

The ARM varies according to the index to which it is pegged. The principal requirements for that index are that it be independent of the issuer and easily verifiable by the borrower. In practice, some lenders use monthly averages of rates while others use the rate of the week. A Colorado savings and loan executive has found 80 different ARM variants in his state. Nevertheless, several types are beginning to emerge as the most acceptable.

A survey by the Mortgage Guaranty Insurance Corp. of ARMS at 500 commercial and savings banks, savings and loan associations, and mortgage bankers nationwide revealed the lenders were equally divided on the choice of index between the Federal Home Loan Bank Board average mortgage contract rate on existing houses and the three- or six-month Treasury bills (each 27 percent). Eighteen percent chose the FHLBB cost-of-funds index, while only 6 percent selected longer Treasury securities (one- to five-year maturities). A full 28 percent were undecided.

(This survey was completed last May, just after federal regulators finalized their regulations on adjustables and before the secondary market makers decreed what types they would buy. Therefore the survey reflects activity in other parts of the country based on ARM predecessors, the variable- and renegotiated-rate mortgages. Nevertheless, it indicates what types of ARMs customers may be most willing to accept at the outset.)

The choice of index is determined to a large extent by what the secondary market -- those institutions that buy mortgages from the original lender -- will accept. FHLMC, or Freddie Mac, currently permits just two indices: the Federal Home Loan Bank Board average mortgage rate for existing houses, with interest and payments adjustable annually, and the same program with a 2 percent annual maximum interest-rate adjustment. While FNMA, or Fannie Mae, allows eight indices, the mix of its commitments to buy ARMs indicates which are the most widely offered by lenders. Of the $5.3 million it has pledged, $3 million is in one of the simplest, middle-of-the-road plans: interest rate and payment changes once a year with no caps on the amount interest rates can be adjusted, but a maximum payment adjustment of 7.5 percent each year. Fannie Mae is also planning to buy $1.7 billion in mortgages with five-year rate and payment changes but no caps.

Of all the indices mentioned, the six-month T-bill shows the most volatility, both up and down. The FHLBB cost-of-funds index is the most stable, with the index for the average of mortgages on existing homes in the medium range in terms of volatility, although it showed substantial movement last year.

Long-term interest rates and indices generally tend to be higher than short-term rates. Housing economist Dale Riordan believes a one- to five-year T-bill index is therefore not as well-suited for ARMS, which are essentially short-term loans renewed at regular intervals. So, says Fannie Mae, "there is a trade-off between the volatility of interest and payment levels and locking in payments for a longer period at possibly higher levels."

Of the dozen ARM lenders contacted in the Washington-Baltimore area, four are using the FHLBB mortgage rate for existing homes without cap as an index. Because this lags behind current market rates, lenders add a margin to make up the difference. Two lenders use the Freddie Mac auction rate, which reflects current market rates. Five use six-month T-bill rates (one also uses three-month T-bill rates). A single company chose the three-year Treasury security index.

All the savings and loan associations use the one-year FHLBB index. All those choosing T-bill indices are mortgage bankers. The reason for this division lies in secondary-market acceptance based on investors' yield requirements. A number of the mortgage bankers plan to sell their loans to private investors who demand higher yields. So their effective interest rates are generally higher.

But then, so are the dollar limits to their loans. The maximum loan amount acceptable to Fannie Mae and Freddie Mac is $98,500. Mortgage bankers not dealing with them make loans up to $200,000, depending on the amount of the down payment.

In the MGIC survey, half the lenders opt for a semiannual rate adjustment; another quarter opt for annual changes. About 15 percent adjust either quarterly or monthly. Similarly, half the area lenders adjust rates annually; five do it every six months, and one every three months. Mortgage bankers tend to adjust rates more often than savings and loans do.

Nationally, a third of the lenders in the survey adjust the monthly payment annually. Slightly fewer, 29 percent, do it twice a year, and 22 percent do it every two to three years. Only 8 percent change it quarterly and none monthly, as permitted by regulators and feared by consumer organizations. Locally, no mortgage lenders change the payments more often than once a year. They were equally divided between those with annual adjustments and those with three-year adjustments.

When the interest rate rises faster than the payments, negative amortization occurs. This necessitates the addition of unpaid interest to the mortgage principal. About half those surveyed nationally and locally permit negative amortization. However, every three years, or whenever the payments are adjusted, the payments must be increased to fully amortize the loan. None of the lenders surveyed here allows an extension to a 40-year mortgage term in place of negative amortization.

Just three of the 12 local lenders place a 2 percent annual cap on the amount interest rates can rise. There is no percentage limit on the dollar amount monthly payments can go up. (By law there is no limit on the amount they can fall.) Only one lender permits a graduated payment plan in conjunction with an ARM, although several others said they were planning to do so in the future.

In the national poll, one-third of the lenders stated in May they would discount the initial interest rate between one to three percentage points (100 to 300 basis points) as an inducement to customers to take ARMs. This was one of the original selling points by ARM originators.

In fact, the differences between ARM and conventional loan rates are small, due primarily to the high cost of short-term money. At Freddie Mac's auction of two weeks ago, the average yield on fixed-rate mortgages was 17.467 percent, including a 0.375 percent servicing fee. ARMs with 2 percent interest-rate caps yielded 16.685; and those with no interest-rate cap, 16.401 percent. That makes a maximum difference of 106 basis points between fixed and adjustable rates.

Fannie Mae's average auction rate for fixed loans was then 16.938. Its lowest adjustable rate yield (for a five-year interest and payment change loan) was 16.60 percent; its highest (for a six-months interest and payment change loan) was 17.902. That means that some ARMs currently have higher interest rates than conventional mortgages, because short-term interest rates are higher than long-term rates.

The rates charged the home buyer by various local lenders naturally vary more widely than the averages in the secondary market, since each lender's margin is different. The margin reflects how much overhead and profit each one builds into each loan. It remains constant over the life of the mortgage. It is difficult to compare rates because terms and number of points differ. Effective yields -- the true cost to the borrower -- ranged from 15.6 percent to 20.2 percent in this area. That compared with 16.75 percent to 18 percent for fixed-rate loans with similar down payments.

Many mortgage bankers charge a higher effective rate than savings and loans, but a lower nominal rate. This means that although the homeowner will have lower monthly payments on a loan of comparable value, there will be (more) negative amortization with the result that the owner will have less equity appreciation in the house.

For example, John Ruppert, a loan officer with Banco Mortgage Co., compared his firm's plan with one offered by several other area mortgage bankers. On a $100,000 loan at 16.25 percent, Banco's monthly payment is $1,325; on the others, $1,166. After three years, a Banco customer will have paid $5,624 more in monthly payments. However, negative amortization will have cost the owner with the other plan $15,948. So the Banco customer, according to Ruppert, is more than $10,000 ahead.

Moreover, after three years the homeowner's payment is adjusted to the effective interest-rate level on the principal and the unpaid interest. If you assume the market rate is still 16.25, the homeowner's monthly payment will rise to $1845.

At a time when house prices appear to be rising more slowly -- in some cases actually declining -- Banco counsels against negative amortization. Saul's Cox makes the opposite case. A lower nominal rate allows more people to qualify for a mortgage, or qualify for a larger mortgage. This is a particularly good deal if the homeowner plans to sell after three years. Otherwise it is advantageous if interest rates fall.

Yet, for all the talk about ARMS, most of it is still just that. To the limited extent that any residential financing is going on, the movement is in seller subsidies or buydowns. These lower the mortgage interest rate -- for a few years or the life of the loan -- by up to five percentage points off market rates. The buyer knows in advance what his or her rate will be in the future.

Most lenders interviewed suggest that subsidies and buydowns will cease when market rates fall to 13 percent or 14 percent. Others believe they will always be an acceptable form of financing, but will diminish in importance. Three of the dozen lenders already combine buydowns and ARMs, and more are considering it. Yet for most, ARM looks like the right thing at the wrong time.