With mortgage interest rates at their lowest point in seven years, consumers have abandoned adjustable-rate mortgages as they crowd into banks seeking to lock in the low rates with fixed-rate loans.
The latest figures from the Federal Home Loan Bank Board show that, of new loans being made today, 15 percent are adjustable-rate mortgages, a drop from a high of 62 percent in 1984.
And some Washington-area lenders said they believe the popularity of adjustables has fallen even lower than the bank board's figures show.
"Of the new business we are getting, very, very few people are applying for adjustables," said Janet L. Pagin, assistant vice president for residential permanent lending for First American Savings & Loan of Woodbridge. "In fact, I haven't taken an application for an adjustable for quite a while."
Pagin said that of the new loans First American is making today, fewer than 7 percent are adjustable-rate mortgages.
Thomas Edmonds, vice president and regional manager for United Virginia Mortgage Corp., said his company has not taken an application for an adjustable-rate mortgage in six months.
"As long as fixed rates are this low 9 1/2 percent , I don't think we'll see much interest in adjustables," Edmonds said.
One reason adjustables are relatively unpopular today, the lenders said, is because starting interest rates for adjustables are not much lower than rates for fixed loans.
"You would be crazy to go with an adjustable today because after the first year it would almost surely go up, probably above the point where fixed rates are today," Pagin said. "There's no reason not to lock in with the fixed rates that are available."
Back in 1983, when mortgage rates were 13 1/2 percent, or higher, adjustables were being offered with starter rates as low as 10 percent, a spread that could make a big difference for borrowers.
Today, adjustables are available at about 8 percent, 1 1/2 percentage points below fixed-rate mortgages, and few consumers find the lower adjustable rate enough of an incentive to agree to the additional risk that the interest rates might rise.
The reason the spread between adjustable- and fixed-rate loans is not wider, lenders said, is because investors are not expecting the long-term inflation that pushes up interest rates on long-term borrowing such as mortgages.
"With the fall in the price of oil, people have decided that inflation is basically gone," said Michael J. Lea, chief economist with the Federal Home Loan Mortgage Corp. "That's why the spread between long- and short-term money has narrowed and why you don't have adjustables being offered at 6 percent."
As a comparison, an adjustable-rate loan with a starting rate of 8 percent and an annual adjustment cap of 2 percent would adjust upward to 10 percent the first year, unless mortgage interest rates continue to fall, which most economists consider unlikely. If rates went back up to 12 or 13 percent -- last year's level -- the loan could easily adjust up another two percentage points to 12 percent during the second year. The average rate for the loan during the first three years would be 10 percent, a little higher than the market rate of 9 1/2 percent for fixed-rate loans available today.
"With an adjustable, the borrower is being asked to take on risk, and with a starting rate of 8 percent they don't feel they are being adequately compensated for that risk," Lea said. "Adjustables just aren't very popular under those conditions."
Adjustables aren't very popular with lenders at this point either, said George C. Alexander, director of product and lender marketing with the Federal National Mortgage Asociation.
"Lenders aren't pushing them, which reflects the continued uncertainty on the part of most lenders about where interest rates will go from here," Alexander said. "They don't want to offer low starting rates because the bottom line is that, the lower they start an adjustable, the lower the rate the lender will average for the loan. There's a lot of hesitancy about them."
Alexander said he also believes there is "something psychological" about single-digit mortgage rates, and that as long as rates are below 10 percent, people will try to lock in the advantage with fixed-rate loans.
At the same time that consumers are shying away from adjustables, people with adjustable-rate mortgages are not necessarily refinancing just to get a fixed-rate mortgage, Edmonds said.
"With rates down, most adjustable-rate loans are also down to the market level, and there is little incentive to refinance," Edmonds said. "The people with adjustables who have refinanced are those with the early ARMs, the loans that had few of the consumer protections that were developed later."
For people who have an adjustable-rate mortgage and are considering refinancing, Edmonds said they should decide first how long they intend to be in their home. If it is less than three years, it probably is not worth the trouble and cost.
Refinancing generally costs between 4 and 6 percentage points of the loan amount, to cover discount points and settlement fees. The rule of thumb for refinancing, lenders say, is to go ahead if it is possible to make up the costs within two to three years.
"With an adjustable that is down at the market rate now, the break-even point for recovering your costs is further down the road," Edmonds said. "If your loan is already at 10 percent, switching to a fixed-rate loan at 9 1/2 is not going to give you much savings the first year."
Homeowners interested in refinancing an adjustable-rate mortgage should consider whether their loan is scheduled to adjust up in the future even if rates do not go up. Some ARMs, particularly those given at low teaser rates, are written so they may be adjusted upward even when rates are coming down. Lenders also say that persons with adjustables should look at whether the loan has a floor, or a lower limit, for the interest rate.
Other provisions to watch out for are adjustables with no interest rate limit during the life of the loan and any loan with negative amortization, which means that the loan amount increases instead of decreases, because of monthly payments set lower than the monthly cost of the loan.
Stephen Cox, senior vice president with B. F. Saul Mortgage Corp., said that despite the lack of low starting rates for adjustables, some people might want to consider ARMs, particularly if they plan to move again in a few years.
"If you plan to be in the house for only two or three years, and if rates do not go up, an ARM could out-perform a fixed-rate loan over the next couple of years," Cox said. "If you believe rates are going to continue to fall, then an adjustable could do even better."
Cox said another reason a family might want to consider an adjustable is if they cannot qualify for a fixed-rate loan at market rate.
Lea, however, said he believes most people who cannot qualify for a fixed-rate loan are choosing instead to lower their expectations and to take a smaller house or come up with a larger down payment.
"People like knowing what to expect from their mortgage," Lea said. "They will go with the fixed-rate if they can."