As interest rates slowly rise, local mortgage professionals have noted that borrowers with adjustable-rate mortgages are weighing other options, with some opting to refinance into fixed-rate loans. However, ARMs remain popular in the mortgage marketplace.
Local lenders say some people, fearing that rates will continue to rise, are refinancing out of adjustable-rate loans. Those with existing interest-only loans and option-ARMs are the most likely candidates to take immediate action.
Rick Fedele, president and founder of Summit Mortgage in Boston, said a small number of homeowners with ARMs are scurrying to refinance now before interest rates rise further. He said those are mostly people who secured option-ARMs, where the amount a homeowner pays changes month to month with the changing rates.
“I don’t think people are doing those short-term loans any more,” said Fedele.
Fedele said even when rates were low, Summit was not issuing a lot of ARMs with monthly rate adjustments. “I just never liked them because I saw this [rising interest rates] happening,” he said. “They might have saved in the first year or so, but today they are not happy.”
But homeowners who locked into three-, five- and seven-year ARMs a year or two ago most likely are happy they did and are not looking at any kind of increase for awhile, Fedele said. With such loans homeowners have locked in at a low initial rate for a set amount of time before the rate begins to adjust to the market on a yearly basis. Because adjustable-rate mortgages typically carry a lower initial interest rate than do fixed-rate loans, they are often used by people who know they will not remain for an extended period in the home they have purchased.
“They’ve got some time. The rate they got a year ago is so great,” he said.
Fedele said deciding which type of loan is best for a particular borrowers has gotten harder with the interest-rate gap between ARMs and fixed-rate mortgages shrinking. But the fact is that, to varying degrees, adjustable-rate loans do cut down on monthly mortgage payments in the early years of the loan.
He said ARMs continue to appeal to the growing condominium crowd, who tend to be more transient in nature. If the borrower does plan to leave the home or condo in a few years, the savings with an adjustable-rate loan can be substantial, Fedele said.
“I can’t see paying extra,” said Fedele, who is paying off his own home with a five-year ARM. He added that it’s a house he plans to never leave.
‘Thought and Analysis’
However, Eric Nelson, president of Milford-based United Funding Corp., said he has seen a substantial migration away from ARMs into more stable loan products such as a 30-year fixed. He said about 25 percent of his clients with ARMs recently have asked to talk about other options.
“I actually see a strong trend right now,” said Nelson. “If someone is concerned, then my recommendation is let’s look at a long-term option. Go the fixed-rate route because that’s going to give you the peace of mind. Those people don’t want to get stuck in worst-case scenarios. No one really knows how high the rates will go.”
Nelson and others say the attraction to adjustable-rate mortgages is directly tied to low rates, and for a number of people, it meets their needs. But Nelson said ARMs are losing popularity.
“Let’s face it, a lot of people know rates are on the rise. You’ve got to think about the risk. I think people are starting to weigh the risks,” he said.
Federal Reserve Chairman Alan Greenspan recently has issued warnings about those risks.
“Over the past few years, a great deal of attention has focused on the growing range of loan choices available to mortgage borrowers,” Greenspan recently told the American Bankers Association. “The menu, as you know, now features a long list of novel mortgage products, not only interest-only mortgages but also mortgages with 40-year amortization schedules and option-ARMs, which allow for a limited amount of negative amortization. These products could be cause for some concern both because they expose borrowers to more interest-rate and house-price risk than the standard 30-year, fixed-rate mortgage and because they are seen as vehicles that enable marginally qualified, highly leveraged borrowers to purchase homes at inflated prices. In the event of widespread cooling in house prices, these borrowers, and the institutions that service them, could be exposed to significant losses.”
Record-low interest rates drew many people into the real estate market in recent years. The Mortgage Bankers Association, a national trade group, reports about 15 percent of American homeowners have ARMs. In the past three years, interest rates for some adjustable-rate loans dipped below 4 percent. Last week, however, the average interest rate on a five-year adjustable loan was 5.88 percent, according to Bankrate.com. The average rate on a one-year ARM was 5.33 percent. The average 30-year fixed-rate mortgage was at 6.34 percent nationally last week.
While rates are rising, it may take some time to determine just how many borrowers ultimately will opt to refinance into fixed-rate loans because the scheduled changes on adjustable-rate mortgages may not occur for months or years.
“It’s a small percentage [of homeowners] that are under review at any given time,” said Jim Dougherty, executive director of the Massachusetts Mortgage Association.
He said worst-case-scenario tales tied to ARMs and rising rates are not indicative of the current mortgage market. “You don’t take one story and base your case on it,” he said. “For a lot of people it’s [adjustable-rate mortgages] a really excellent vehicle.”
But when the rate-lock period on adjustable-rate loans expires, borrowers likely will shop around before just accepting the increase, an option that was not always available for homeowners, he said.
In 1979, inflation under the Carter administration was rampant. Interest rates on mortgages were approaching 20 percent, said Dougherty.
“The housing market essentially shut down,” he said.
Dougherty said through innovative thinking adjustable-rate mortgages were created, and along with them came the “birth of the mortgage broker.”
In the early 1980s, ARMs enabled lenders to offer homebuyers a 13 percent introductory rate, which today sounds high, but for the time was quite a deal, he said.
He said ARMs and interest-only loans continue to be an attractive option because they allow buyers to maximize their purchase.
According to Robert B. Kimmett, senior vice president of public relations and marketing for the Massachusetts Credit Union League, both lenders and borrowers must weigh individual needs and circumstances when assessing mortgage possibilities.
“I think some people panic, so it really calls for some thought and analysis on the part of the consumer,” Kimmett said. “The [lending] institution should be working with individual consumers [to identify the best loan type].”
