Mortgage rates drift downward
By Holden Lewis • Bankrate.com

Mortgage rates didn't move much in a week of unsurprising economic reports. The best news was that the gap widened between adjustable-rate mortgages and fixed-rate loans.

The benchmark 30-year fixed-rate mortgage fell 2 basis points to 6.43 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 0.32 discount and origination points. One year ago, the mortgage index was 6 percent; four weeks ago, it was 6.37 percent.

The 15-year fixed-rate mortgage fell 1 basis point to 6.08 percent. The 5/1 adjustable-rate mortgage fell 6 basis points to 6.07 percent.

Do the math and you'll see that one week ago, the average rate on a 5/1 ARM was higher than that on a 15-year fixed -- 6.13 percent, compared to 6.09 percent. It's unusual for the rate on a five-year loan to rise higher than the rate on a 15-year loan. But we've been living in unusual times, with ARM rates rising much faster than fixed rates.

The gap shrank
A year ago, a one-year ARM's rate was more than a percentage point lower than the rate on a 30-year fixed. The average rate on a 5/1 ARM was about half a point lower than the 30-year fixed.

Then the differences began to shrink. Between spring and fall 2005, the rate on the 30-year fixed fell, while rates on one-year and 5/1 ARMs rose. Then fixed rates started rising, too -- but ARM rates went up faster. ARMs lost some of their appeal because their low-rate advantage was partly erased.

This week, ARM rates fell more than fixed rates. That normally gives borrowers an incentive to get lower-rate ARMs instead of higher-rate fixed-rate mortgages. Borrowers responded predictably: According to the Mortgage Bankers Association, 28.8 percent of loan applicants asked for ARMs last week, compared to 27.9 percent the previous week.

Too many ARMs?
Some observers worry that too many people have been getting adjustable-rate mortgages. They predict that a wave of foreclosures will sweep over the real estate landscape in the next few years as ARM rates rise abruptly and home values stagnate or fall. Some homeowners will get stuck, unable to afford the suddenly higher monthly payments, but unwilling to sell their houses at a loss.

A certain subset of borrowers is most vulnerable: Those who bought homes in 2004 or 2005, made down payments of 15 percent or less, and got interest-only or payment-option ARMs with ultra-low introductory "teaser rates" that last for one to 24 months before the loan is reset with a higher rate. That describes hundreds of thousands of people, with a total of about $200 billion in mortgage debt, says Christopher Cagan, director of research and analytics for First American Real Estate Solutions.

He wouldn't be surprised if 90 percent of those borrowers default on their mortgages. "If you didn't read the loan papers, or you thought values would rise 20 percent-a-year forever, or you don't know what negative amortization means, you're going to get stung," Cagan says.

1 in 4 face payment shock
Negative amortization is when the minimum monthly payment doesn't even cover the interest charged, so you owe more at the end of the month than at the beginning of the month, even after making a minimum payment. Many payment-option ARMs allow negative amortization.

The best way to avoid this jam is to refinance before the loan rate jumps. That's the advice that a lot of mortgage bankers are giving. "Twenty-five percent of mortgages are ARMs that are scheduled to adjust in the next two years," says Bob Walters, economist for Quicken Loans. "These homeowners will continue to take advantage of the opportunity to refinance into a fixed-rate program."

You can take that as a statement of fact as well as a sales pitch. It's still valid advice.