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Freddie Mac releases results of annual ARM survey.

FREDDIE MAC RELEASED THE RESULTS OF ITS 21st Annual Adjustable-Rate Mortgage (ARM) Survey, which found greater lender discounts for introductory ARM rates; smaller interest-payment savings for ARMs relative to fixed-rate loans; and increasing popularity of hybrid ARMs relative to one-year adjustables.

"The Federal Reserve ratcheted up short-term interest rates five times over the last half of 2004, raising their federal funds target from 1 percent to 2.25 percent," said Frank Nothaft, Freddie Mac's vice president and chief economist. "Long-term mortgage rates were little affected, averaging about the same at the end of the year as they did in the beginning. Initial rates on ARMs, however, rose by about 40 basis points over the course of the year because they typically are priced off of financial instruments with shorter maturities that match the length of the initial adjustment period."

The survey, based on data collected Dec. 20 to Dec. 23, 2004, found that starting rates for ARMs would have increased even further if not for greater use of initial-rate discounts by lenders. In order to encourage homeowners to opt for an ARM, lenders typically offer a lower initial interest rate than what the fully adjusted rate would be at the time of origination (i.e., the underlying index rate plus the margin). At the beginning of 2004, this discount amounted to about three-eighths of a percentage point for conventional, conforming one-year Treasury-indexed ARMs. By the end of the year it had increased by almost a full percentage point to an average of 1.34 percentage points. Over the last 21 years, initial one-year discounts averaged about 1.7 percentage points.

"When the interest-rate difference between a 30-year, fixed-rate mortgage [FRM] and the fully indexed ARM rate decreases, lenders generally offer a larger initial rate discount on the ARM," said Nothaft. "The larger initial discounts increase the initial rate benefit of an ARM compared with fixed-rate loans, helping lenders to maintain ARM originations."

Last year started off with a steep Treasury yield curve, where the rate spread between 10-year and one-year constant-maturity yields was 2.91 percentage points, yet ended the year around 1.57 percentage points. During periods of a steep yield curve, ARMs become more popular among consumers.

"For instance, in 2004 the ARM share of mortgage originations peaked in June at 40 percent of conventional home-purchase loan activity," said Nothaft, referencing Federal Housing Finance Board (FHFB) data. "This followed a 2.94 percentage point high for the year in the 10-year to one-year Treasury rate spread in May."

Through November, ARMs accounted for 34 percent of the conventional purchase-money market in 2004. This was the highest annual ARM share since 1994, when it was 39 percent. The highest annual ARM share occurred in 1984 at 62 percent, the same year Freddie Mac began its annual ARM survey. Compared with Freddie Mac's previous annual ARM survey, the interest rate savings on ARMs are now smaller, even with the initial rate discounts that are offered by lenders.

Over the last several years, annually adjusting ARMs with an initial fixed-rate period of more than one year, known as hybrid ARMs, have grown in popularity. According to FHFB data, hybrid ARMs accounted for the majority of purchase-money ARMs by 2002. Within that product type, ARMs with an initial fixed-rate period of five years, known as 5/1 ARMs, have been the dominant choice of consumers.

"In 2004, two of five ARMs and three of five hybrids were 5/1 ARMs," said Nothaft. "Starting [January 2005], Freddie Mac has begun collecting 5/1 hybrid ARM data in our weekly Primary Mortgage Market Survey, and will begin releasing the data this month. This will provide families with additional information on the interest rates and fees associated with 5/1 hybrids, to help them as they compare costs of different loan types."

The average initial interest rate on 5/1 hybrid ARMs was 4.99 percent in the 21st Annual ARM Survey, or 0.82 percentage points above the rate on the traditional one-year adjustable, and 0.65 percentage points below the rate on a 30-year, fixed-rate mortgage.

In all, according to Freddie Mac's ARM survey, potential homebuyers and existing homeowners opting for a Treasury-indexed ARM amortized over 30 years with a loan amount of about $175,000 can expect initial savings (up until the first rate adjustment) over a FRM of up to:

* about $2,022 for one-year conforming ARMs;

* about $6,510 for one-year jumbo ARMs (assuming an average loan amount of $515,000);

* roughly $2,245 for ARMs insured by the FHA;

* almost $4,544 for 3/1 ARMs (wherein the first rate adjustment occurs in three years and then adjusts on an annual basis);

* about $3,329 for 3/3 ARMs (wherein the mortgage rate adjusts every three years);

* nearly $4,973 for 5/1 ARMs (wherein the first rate adjustment occurs in five years and then adjusts on an annual basis);

* about $3,881 for a 7/1 ARM (wherein the first rate adjustment occurs in seven years and then adjusts on an annual basis); and

* almost $4,498 for 10/1 ARMs (wherein the first rate adjustment occurs in 10 years and then adjusts on an annual basis).
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Title Annotation:Business Alert
Publication:Mortgage Banking
Geographic Code:1USA
Date:Feb 1, 2005
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