◈ Floating Mortgages Lose Appeal
Zigzag interest rates have upended a lot of things, including the appeal of an adjustable- rate mortgage.
When the Federal Reserve began aggressively increasing interest rates last year, home buyers turned to ARMs, hoping to lower their mortgage costs. Now, they aren’t saving much money at all, and in some cases they are paying more.
One common type of ARM came with a rate of about 7.04% for the first five years on average this month, ac-cording to Optimal Blue, a mortgage technology and data company. That was higher than the comparable 30-year fixed mortgage rate of 6.86%.
ARMs have rates that are fixed for the first few years and then rise and fall periodically with market conditions. Historically, the initial rate on these loans was significantly lower than the rate on a fixed mortgage because of their shorter length.
Many borrowers are still calling their lenders to inquire about how much they can save with an adjustable rate.
“They almost always ask,” says Kevin Leibowitz, who runs the New York brokerage Grayton Mortgage.
When Louis Blacker and Ellie Bendetson found a home to buy in Los Angeles in the spring, the first-time buyers offered an ARM that had a rate of 6.5% for the first 10 years. It was barely below the 6.625% they were offered on a 30-year fixed.
“To me, that didn’t quite feel like it was worth it,” Blacker said. They went with the fixed, though he said he might have been persuaded if the ARM rate had been lower.
The Fed’s rate-increasing campaign has weighed on the housing market for nearly two years. Though rates have fallen in recent weeks, they are still high compared with those of 2021, sidelining buy-ers and sellers alike.
The Fed also is behind the diminishing attractiveness of ARMs.
ARM interest rates were still significantly lower than those on fixed-rate mortgages throughout 2022, when the Fed first started raising rates. Lenders were slower to lift rates on ARMs, in part because banks often make the adjustable loans to well-off customers whom they consider low risk.
But the two types of mortgages follow different benchmarks. The 30-year fixed mortgage rates tend to rise and fall along with longer-term rates, typically the yield on the 10-year U.S. Treasury. The initial rates on ARMs tend to track shorter-term rates.
The Fed’s moves affect
short-term rates most directly. And the central bank lifted short-term rates so much that they became higher than long-term rates, an unusual phenomenon known as an inverted yield curve. That made it harder for lenders to keep offering attractive rates on ARMs.
The dynamic hasn’t changed much since the Fed signaled this month that it is likely done raising rates because inflation is coming down. Since then, long-term rates have fallen.
But if the Fed starts cutting rates, short-term rates could drop back below long-term rates, reintroducing an ARM benefit, said Barry Habib, chief executive of mortgage-software company Highway.
ARMs made up just over 7% of all mortgage applications this year, according to the Mortgage Bankers Association. Though they aren’t a huge part of the market, they doubled as a share of all mortgage applications in 2022 and 2023 from the two years prior.
Before the 2008-09 financial crisis, ARMs made up as much as one-third of the mortgage market, according to the MBA. Lending terms were loose and borrowers were lured by extremely low teaser rates that could start adjusting after only a year.
Many loans soured after the teaser rates ended and interest costs jumped, resulting in widespread foreclosures and losses for lenders. Regula-tors then drew up rules for standard ARMs that say a lender has to be sure the borrower can afford the maximum potential rate on the mortgage during the first five years.
Today, ARMs generally don’t start floating for at least five years. Lenders also don’t have as much wiggle room to lower the initial rate.
The lowest ARM rates are typically reserved for affluent buyers with strong credit, who sometimes take loans that don’t get sold to Fannie Mae and Freddie Mac. Banks that issue the ARMs often keep the loans on their balance sheets, allowing them more flexibility to adjust the initial rate.
They might offer the below-market rates to lure the customers’ other business, such as investments and deposits. In the first nine months of 2023, all of the 10 largest producers of ARMs were banks or credit unions, according to Inside Mortgage Finance, an industry research group.
An ARM made sense for Mark and Elaine Whalen when they purchased a vacation home in Bourne, Mass., this fall. A mortgage lender friend who works at a bank got them a rate of 6.75% for the first seven years. After that, the rate resets every six months.
They hope to sell their primary home and pay off some or all of the ARM before it starts floating. They passed on a 30-year fixed with a 7.25% rate. “We were really fortunate,” Mark Whalen said.D
<WENDESDAY, DECEMBER 27, THE WALL STREET JOURNAL>