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Lending

Is the growing market share of ARMs cause for concern?

Capital Economics wants to know

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Capital Economics states the share of adjustable-rate mortgages is growing, though it still remains small. New ARMs, as per current regulations, primarily contain longer term fixed interest rate periods.

The economics company states the mortgages appear to be in the middle of something akin to a renaissance.

"Freddie Mac data show that the share of loan applications which are for ARMs increased from 9% in November 2012 to 12.5% in May 2013, while their latest ARM survey suggests that the popularity of ARMs has risen further since then."

And here's a reason for this growth:

"The recent rise in mortgage interest rates has primarily effected long-duration loans and has left short-term loans looking relatively cheap."

Here are three reasons they give as to why the rise of ARMs are not particularly alarming.

1: Market share and volume remain at traditional lows. The average share of ARM applications in 1985 was 24%, nearly double the current share. 

2: The 5/1 is the most popular product, followed by the 3/1, 7/1 and 10/1 mortgage. At an interest rate of 3.15% (the current 5/1 rate), a borrower will have repaid 11% of the outstanding mortgage balance after five years. This rises to 15% after seven years and 23% after 10 years. This equity buffer offers lenders a degree of protection should borrowers default when the rate begins to float.

3: Unlike during the housing boom, ARMs are not being used to lure borrowers into cheap teaser rates which subsequently reset at a rate beyond borrowers’ means. Indeed, the CFPB’s ability-to-repay rule no longer allows such mortgages to be written.

Note: Thank you property economist Paul Diggle for the excellent research note.

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