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Interest-rate worries reignite a race for ARMs
By Michael
D. Larson • Bankrate.com
 Mortgage
hunters of the world, it's time to ARM yourselves.
Bond traders are scouring for inflation in every
economic press release from here to Tokyo, and that means 30-year
fixed-rate mortgages below 6.5, 7 or even 8 percent are rapidly
becoming a thing of the past.
As a result, adjustable-rate mortgages now make
sense for many consumers. But because many borrowers haven't had
to study or even think about ARMs in a long while, experts say it's
time for a refresher course on how they work.
"Qualifying rates, payments and actual costs
to the borrower over the long term are lower today with the adjustable-rate
loan," says Brad Blackwell, senior vice president for retail mortgage
banking at Washington
Mutual Inc. The nation's largest thrift, based in Seattle,
specializes in adjustable rate lending.
ARMs
looking more attractive
Much like the tide, the popularity of adjustable-rate mortgages
rises and falls with forces beyond its control. When it looks like
inflation might become a problem in the economy, mortgage rates
start heading higher. Each uptick makes it a little tougher for
potential buyers to afford homes. That, in turn, makes ARMs look
more popular, because they generally allow people to pay less early
on in the mortgage term on the condition they'll agree to pay more
later if rates rise.
A wider
array of choices
Borrowers can find more types of adjustable-rate mortgages these
days, depending on their needs and tolerance for risk.
For the most market-savvy, there are short-term
ARMs with an initial fixed period of as little as six months to
one year. Customers might choose the product because they're willing
to stomach frequent payment adjustments in order to free up more
money to invest in the stock market or otherwise earn a higher rate
of return.
Longer-term ARMs that start off with fixed rates
for the first couple of years and adjust annually thereafter offer
a bit more stability. A 3/1 ARM, for example, stays fixed for three
years, then can be adjusted once a year. There are also 5/1, 7/1
and 10/1 ARMs available, so borrowers can match their fixed period
to the number of years they expect to live in their homes. That
makes them a good deal for people who want to save a bit on the
interest rate and who have well-defined housing goals.
"(Consumers are) doing a much better job of
matching their borrowing needs with their expected tenure that they're
going to be in their home," says Larry Hamilton, chief executive
officer of Birmingham, Ala.-based SouthTrust
Corp.'s mortgage division.
"We don't have a consumer out there that absolutely
has to have a 30-year mortgage to sleep at night, and since most
30-year mortgages prepay in seven or eight years, you can make the
case: 'Why does anybody ever need a 30-year fixed rate?' "
Still, some borrowers choose ARMs that closely
resemble fixed mortgages. These "two-step" products feature fixed
payments for many months, followed by a one-time adjustment to current
market rates.
A 7/23 would offer seven years of stability,
one change and then 23 more years of fixed payments, for example.
These mortgages offer many of the same benefits of other long-term
ARMs, but they typically carry a bit more risk. That's because lenders
can increase the rate much more at the time of the one adjustment
than they are allowed to each year with regular long-term ARMs.
Avoiding
the adjustment
"The most common question for adjustables, especially longer-term
adjustables, is 'What is the likelihood that I'm going to endure
an adjustment during the time that I'll be there?'" says Brian Israel,
vice president of Chicago-based Harris Trust
and Savings Bank's residential mortgage division. "Probably
90-plus percent of the people who take seven- or 10-year programs
do not ever see an adjustment."
Consumers may also enjoy more flexibility with
ARM lenders than they do with fixed-rate mortgage originators. Because
many ARMs are kept on the company books rather than sold into the
secondary market in the manner of most 30-year loans, they often
don't have to meet strict Fannie Mae and Freddie Mac guidelines.
"There can be substantially more financial flexibility
for a borrower who takes an ARM," says Blackwell of Washington Mutual.
The company offers an "Option ARM," for example, which lets people
choose from a menu of payment options. One borrower might temporarily
make interest-only payments to free up some cash, while another
could follow the accelerated payment schedule provided in order
to retire the 30-year mortgage in 15 years.
While the flexibility of ARMs makes them an
attractive financing option, borrowers still need to make sure they
know what they're getting. Loan holders could easily see their payments
skyrocket if 1980s-like double-digit mortgage rates return, and
that could plunge unprepared consumers into foreclosure.
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