Freddie Mac releases results of annual ARM survey.

Position:Business Alert

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...

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