Freddie Mac: Hybrid ARMs are “hot”

Annual Adjustable-Rate Mortgage Survey shows impact of low interest rates

Hybrid adjustable-rate mortgages continue to be the most popular ARM loan product offered by lenders and chosen by borrowers, according to the 31st Annual Adjustable-Rate Mortgage Survey of prime loan offerings from Freddie Mac.

According to Freddie’s survey, which was conducted from Jan. 5 through Jan. 8, 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 7/1, 3/1 and 10/1, Freddie said.

Far less popular among the survey participants are ARMs where the repricing frequency is fixed for the life of the 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.

According to Freddie’s survey, the current low rate environment is contributing to the popularity of ARMs, with current ARM initial-period rates down over 2014’s rates.

“For a one-year, 5/1 or 10/1 Treasury-indexed ARM, the average initial rate was 2.39%, 2.98%, and 3.71%, respectively, down 0.2 percentage points for the one-year and 5/1 products and 0.3 percentage points for the 10/1 ARM,” Freddie said.

Borrowers chose a hybrid ARM because of the “substantial payment savings” during the initial years of the loan, Freddie said. “In early January 2015, 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 0.75 percentage points,” Freddie said.

“For a $250,000 loan, the monthly principal and interest payment on a 5/1 hybrid would be about $103 less than on the 30-year fixed-rate loan over the first five years of the loan,” Freddie added.

And the savings can be even greater on a loan with a high initial balance, according to Frank Nothaft, Freddie Mac’s vice president and chief economist.

“Because consumers who choose an ARM often are taking out a higher-balance loan, their payment savings can add up over the first few years of the loan,” Nothaft said.

“The average loan size for a conventional ARM for home purchase was more than $400,000 during 2014 and about double the size of an average fixed-rate loan, according to data from the Federal Housing Finance Agency. On a $400,000 loan, a family would save about $9,000 during the first five years of a 5/1 hybrid compared with a 30-year fixed-rate loan, based on interest rates collected in our survey. “

Nothaft also predicts that the expected rise in interest rates in 2015 could lead to an increased interest in ARMs.   

"Today's low mortgage rates will not be around forever. Even a majority of the Federal Reserve's policy-making committee expect interest rates to rise by year-end,” Nothaft said. “Higher rates on both ARM and fixed-rate products, and further gains in home values, could lead more borrowers to opt for an ARM.”

According to Nothaft, ARMs comprised about 10% of home-purchase loans in the conventional market, in 2014, citing data from the FHFA. “If fixed-rate loans become more expensive and home values rise further, we expect more consumers to take another look at ARMs and project the ARM share rising to 12% of the conventional home-purchase market in 2015," Nothaft said.

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