[Editor's Note: This analysis of the adjustable-rate-mortgage (ARM) market is part of a two-story package on the U.S. mortgage market. To read the package mainplay - "Mortgage Markets Show Increased Stability, But Limited Opportunity" - please click here.]
Is it the end of the line for the adjustable-rate mortgage (ARM)?
A close look at the interest-rate paradox involving credit cards and ARMs indicates that it may be time to start writing the epitaph for adjustable-rate home loans. Here's why.
The U.S. Federal Reserve's benchmark Federal Funds rate is at all-time lows – with a target rate near 0.00% – but credit-card interest rates linger at record highs. The all-in rate on some credit-card transactions approaches 30%.
You'd think card issuers would be clamoring to lock in rates this high, but just try finding a fixed-rate card these days. It's almost impossible.
It's pretty much either variable rate or nothing. That's a long way away from the 'good ol' days' when offers for 7.9% fixed-rate cards poured in like junkmail.
A very different situation is playing out in the mortgage market. When you take that same ultra-low Fed rate and look at the impact it's had on mortgage-loan rates – including loans offered by the same institutions that offer credit cards – you'll discover a puzzling paradox: While credit-card rates remain near record highs, mortgage rates are near their all-time-record lows.
What's more, almost no one is making adjustable-rate mortgage (ARM) loans – though you'd expect those stereotypically greedy bankers to be pushing them right and left in expectation of raking in huge profits once the Fed puts its "exit strategy" into effect and finally does start raising interest rates. (Admittedly, those ultra-low interest rates have been sustained by government-loan guarantees and increased central-bank purchases of mortgage-backed securities).
The reason could be that consumers simply aren't asking for them. After all, why risk a hike in rates when you can lock in a 30-year mortgage for a recent national average of 5.03%, says Freddie Mac (NYSE: FRE), the nation's second-largest mortgage provider.
Some firms are even offering 15-year mortgages with fixed rates as low as 4.00%.
Indeed, the only borrowers still in love with the idea of adjustable-rate mortgages are probably those who got them three or four years ago, and who have seen their loan rates drop to near 3.0% – with corresponding declines in their monthly housing payments. And with analysts predicting that rates on mortgage loans of all types – including fixed-rate mortgages – will fall, even ARM-holding homeowners are considering a switch to fixed-rate home loans, concludes a recent report in The Wall Street Journal.
So are the fixed-rate credit card and the adjustable-rate mortgage both dead for good?
The answer to the first half of the question is probably "No." Increased competition as the economy continues to recover and issuers adjust to the just-imposed consumer protections for credit-card borrowers will eventually see to that.
It's a different story for ARMs, however. Barring a return to the interest-rate environment of the 1970s, the answer to the question's second half may well be "Yes." The ARM could well be dead.
There's plenty of evidence to support this view.
For starters, the number of new ARMs is down, in part, because the number of new mortgage originations of all types have fallen sharply – from a recent peak of 322,390 in May 2005 to a new low of just 77,222 in November 2009, the most recent month for which full figures are available.
However, the drop in ARM originations has been considerably more drastic: Originations of adjustable mortages have plunged from a high of 146,852 in May 2005 to just 2,225 in December 2009.
The demand for ARMs has been flat for an even-longer stretch. After running as high as 43,983 in February 2007, it plunged to just 10,416 by December 2007, then steadily dwindled to just 2,945 applications in December 2008. The peak for all of 2009 was a mere 4,147 in July, and demand has fallen in every month since.
To further quantify the depth of the decline, consider this: Five years ago – in March 2005 – ARMs made up 45.75% of all mortgages sought for new home purchases. That represented the high-water mark for ARMs.
By December 2007, ARMs accounted for only 7.21% of all new mortgages – and that share hasn't topped 9.0% in any month since. It actually hit a low of 2.85% in February 2009, before rebounding to end the year at 4.52%.
The drop in the dollar value of new ARMs during this same period was also remarkable, falling from a peak of more than $46.8 billion in loans closed in June 2005 to just $865.1 million in December 2009.
The decline in requests for adjustable-rate mortgages for refinancing has been even more dramatic. According to lendingtree.com, the number of homeowners seeking to "refi" into ARMs has collapsed, dropping from more than 60% in early 2005 to less than 1.0% in the final quarter of 2009 – even though the company was offering 5/1 ARMs (adjustable after five years, and yearly thereafter) at rates as low as 3.25% to qualified borrowers.
If you are among those who still prefer adjustable-rate loans to fixed-interest levies, you may soon find this option is only available in the credit-card market. In the mortgage sector, however, the only place you'll find listings for the once-venerable ARMs will be in the Obituary Column.
To the ARM, the message may well be a simple one: R.I.P.
News and Related Story Links:
- Money Morning Analysis of the Mortgage Market (Part I of II):
Mortgage Markets Show Increased Stability, But Limited Opportunity
Official Web Site.
- The Wall Street Journal:
It May Be Time To Give Up Adjustable-Rate Loan.
Corporate Web Site.
- MSN Money:
10 tips on mortgages for 2010.
Adjustable Rate Mortgage.
- Money Morning News Archive:
Exit Strategy Stories.