Rates rise, ARM popularity dips

Adjustable-rate mortgages continue to decline in popularity as they become less attractive when compared to fixed-rate loans.

The benchmark 30-year fixed-rate mortgage rose 7 basis points to 5.91 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.37 discount and origination points. One year ago, the mortgage index was 6.02 percent.

The benchmark 15-year fixed-rate mortgage rose 6 basis points to 5.51 percent. The benchmark 5/1 adjustable-rate mortgage rose 2 basis points to 5.51 percent.

There are many varieties of an adjustable-rate mortgage, or ARM. The most popular is the 5/1 ARM, in which the initial rate lasts five years, then adjusts annually. There are ARMs that have their first adjustment after the first month, after six months, after a year, or after three, seven or 10 years.

Altogether, ARMs constituted 28.5 percent of mortgage applications last week, according to the Mortgage Bankers Association. Last year, they were 34 percent of mortgage applications, and in the first week of the year they were 32.7 percent of all mortgage applications.

ARMs have waned in popularity because they offer less of an advantage over 30-year, fixed-rate mortgages. At the beginning of 2005, the average rate on a 30-year fixed was 5.76 percent and the average rate on the 5/1 ARM was 5.08 percent (see chart). Back then the 5/1 ARM gave borrowers a break of about two-thirds of a percentage point.

Now, the 5/1 ARM's rate is about one-third of a percentage point below that of the 30-year fixed. No wonder that demand for ARMs has lessened: You pay just a little more each month, and your rate is guaranteed for 30 years instead of just five.

Borrowers are much more nimble than they used to be when it comes to refinancing mortgages, says Bob Walters, chief economist for Quicken Loans. He says there has been a discernable trend lately where people are refinancing from ARMs to fixed-rate mortgages. They do it because they expect future ARM rates to rise above today's fixed rates.

Who makes a good candidate for switching from an ARM to a fixed? If you plan to live in your house for at least another six or seven years, and your ARM is set to adjust within three years, "it makes a lot of sense to lock that down" by refinancing to a fixed-rate loan, Walters says.

There's no precise way to analyze the costs versus the benefits of refinancing from an ARM to a fixed-rate loan, because you can only guess what will happen to ARM rates far in the future. Ask a lender or broker to outline a couple of possible outcomes: a worst-case scenario in which the ARM rate rises the maximum, and one in which the rate rises, but not so much. Get an estimate of closing costs and calculate whether it's cheaper in the long run to stick with the ARM or to refinance into a fixed-rate mortgage.