Hybrid ARMs Dominate Mortgage Offerings

Hybrid ARMs continued to be the most popular loan product offered by lenders and chosen by ARM borrowers according to Freddie Mac’s 30th Annual Adjustable-Rate Mortgage (ARM) Survey of prime loan offerings, which was conducted January 6 to January 10,

Homebuyers have preferred fixed-rate mortgages the past few years because of the low interest rates and the certainty of the monthly principal and interest payment. As longer-term rates rise, ARMs with their lower initial interest rates will become more appealing to loan applicants. Hybrid ARMs are particularly attractive because they have an initial extended fixed-rate period of 3 to 10 years — and then adjust annually thereafter. Nearly all of the ARM lenders participating in the survey offered a hybrid. The 5/1 hybrid (a five-year fixed-rate initial period before the rate resets annually) was by far the most common, followed by the 3/1, 7/1 and 10/1. Far less common were ARMs where the re-pricing frequency was fixed for the life of loan, such as a one-year adjustable, a 3/3 ARM (which adjusts once every three years), or a 5/5 ARM (which adjusts every fifth year).

Banks are definitely doing more ARMs because they’re selling the consumer what they’re asking for, which is a lower monthly payment. In early January 2014, the interest rate savings for the 5/1 hybrid ARM with a 30-year term — the most common ARM offered in today’s market — compared to the 30-year fixed-rate mortgage amounted to about 1.36 percentage points. For a $250,000 loan, the monthly principal and interest payment on a 5/1 hybrid would be about $194 less than on the 30-year fixed-rate loan over the first five years of the loan.

Many borrowers with adjustable-rate mortgages were among the first to default during the downturn. When their rates adjusted after an initial teaser period, they were unable to refinance and got stuck owing sharply higher payments. This time around will be different, lenders say, because underwriting standards are tougher for hybrid ARMs, so borrowers will be less likely to get squeezed when interest rates reset. Moreover, regulators have all but banned the interest-only and balloon payment features that made ARMs ticking time bombs during the financial crisis.

For many, it makes a lot of sense to take a shorter-term mortgage, If the borrower is in a situation where they’re not going to be in that home for more than seven years, it would be incorrect for them to take the fixed rate when the ARM is giving them a benefit of lower monthly payments.