A FAREWELL TO ARMS? WITH RATES DROPPING, ADJUSTABLE MORTGAGES ARE GOING UNWANTED.

Byline: Gregory J. Wilcox  Staff Writer

Adjustable rate mortgages have fallen to their lowest level in more than a generation, but their popularity, while rising this year, remained constrained by historical low rates for other products, said a Freddie Mac survey released this week.

This year, as in the past, the traditional 30-year fixed rate mortgage remains the most popular choice among home buyers. But adjustable rate mortgages, known as ARMs, accounted for 17 percent of home loans this year versus 12 percent in 2001.

ARMs carry a lower initial rate because they can adjust.

In a survey for the week ending Dec. 20, the average one-year ARM dipped to 4.07 percent, the lowest level recorded by Freddie Mac since it began tracking the product in the early 1981, when this kind of loan became popular, said Frank Nothaft, the corporation's chief economist.

This kind of rate environment probably won't change much heading into next year, either.

``Over the next few weeks, our expectation is that the current low level of mortgage rates will pretty much continue at the level they are now, with the fixed rate running right around six percent,'' said Nothaft.

The usual suspects of a soft economy and war worries get the credit, he said.

ARMs typically result in a lower monthly mortgage payment, but borrowers run the risk of their cash outlay increasing if the rate adjusts upward. But there probably won't be a rush for this type of product, Nothaft said.

``This mortgage was not very popular among ... shoppers this year, due to the uncertainty of annual adjustments to their monthly payments and the 37-year low in fixed-rate mortgage rates,'' Nothaft said.

Rates on this type of product adjust once a year, with increases capped at two percentage points in either direction.

Sometimes it makes sense for homeowners to refinance when the rate for a traditional mortgage finally sinks below the rate tied to the original ARM.

And sometimes waiting a while can pay off, too, noted Keith T. Gumbinger, vice president of HSH Associates, the nation's largest publisher of mortgage information.

For example, in 2000, some adjustable rate mortgages had an interest rate of 8.5 percent.

Then rates started what turned out to be the prolonged period of decline that persists today.

If the holder of such a mortgage resisted the refinance urge, that rate, since it is capped, would have fallen to 6.5 percent at the end of 2001. And by the end of this year, it would have fallen to 4.5 percent, about 1.5 percentage points below the 30-year-fixed, Gumbinger said.

``You've done damn well if you could stomach holding on to an 8.5 one-year

ARM as rates were falling,'' Gumbinger said.

Hybrid ARMs have become a popular staple of the mortgage sector over the last decade, too, the Freddie Mac survey said.

Interest rates on these products tend to be higher than traditional 1-year ARMs, but usually fall below those of fixed-rate mortgages. Over the last decade, the hybrid ARMs have become more popular.

Freddie Mac said that the most widely offered hybrid ARM was a 3/1, which on average can save a buyer nearly $2,400 in monthly payments for the first year, and almost $7,200 for the initial three years of the loan.

This product has a fixed rate for three years then adjusts annually after that. About 75 percent of the companies that offer adjustable rate products include this in their portfolio, Freddie Mac said.

Second on the list was the 5/1 ARM, which reduces mortgage payments by $1,500 in the first year and reduces the debt burden by $7,700, on average, over the first five years.

``The 3/1 ARM and 5/1 ARM have become increasingly popular in the market because they offer consumers an attractive blend of the lower initial rate benefit of an ARM with the benefit of a fixed-interest obligation, albeit only for a few years,'' Nothaft said.

This is a good option for buyers who know they will be moving soon.

``Why pay the higher cost for 30 years of protection against interest rate shocks, when you will have the loan for no more than five years?,'' he said.

Freddie Mac is a stockholder-owned corporation established by Congress in 1970 to support homeownership and rental housing. The corporation purchases single-family and multifamily residential mortgages and mortgage-related securities.