A recent New York Federal Reserve
report shows that adjustable-rate mortgages fell from a nearly 70% share of the market in 1994 to just 3% in early 2009 as homebuyers grew more wary of the risks associated in these products. One of the government-sponsored enterprises, Freddie Mac
, is also stating it is doubtful the mortgage product will return to those glory days any time soon.
Freddie Mac studied prime loan offerings from Jan. 3 to Jan. 5 of this year, and found that ARMs are financing just 7% of new home purchases. The report from the New York Fed developed two theories for the fall. One, was that when the securitized mortgage market collapsed in 2008, a place where ARMs were predominate, homebuyers had less access to these products.
But the NY Fed's second theory coincided with what Freddie Mac Chief Economist Frank Nothaft found: Homebuyers were simply more aware of the risk.
"Households have become more risk averse following the publicity given to high default rates on subprime ARMs, and the reports of 'payment shock' associated with interest rate resets on ARMs," the NY Fed said in its report.
Nothaft, too, concluded, "Homebuyers have shied away from ARMs because they are wary of the risks. The potential for much larger payments if future interest rates are significantly higher and the high delinquency rates borrowers have experienced on ARMs over the past couple of years have led consumers to prefer fixed-rate loans instead of ARMs."
Of adjustable-rate loans that were offered to homeowners, 5/1 hybrid ARMs are the most popular. Nearly every lender surveyed by Freddie offered one. Seven in 10 lenders offered a 3/1 hybrid ARM, and only 9% of lenders surveyed offered a 3/3 ARM, which adjusts once every three years.
Nothaft added that fixed-rate loans currently continue to stay at such low levels, that homebuyers do not see the incentive for ARMs, which are only slightly lower. The NY Fed drew a similar conclusion as well, citing historical patterns that showed borrowers preferred fixed-rate loans over ARMs when both were advertising low rates.
However, Nothaft expects ARMs to gradually gain back favor with some borrowers, possibly rising to an average 9% market share by the end of 2011.
Write to Jon Prior
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