The average rate for a 5-year ARM loan hit 2.69% last week, the lowest average in more than 40 years. This is according to Freddie Mac’s weekly survey of the mortgage market. At the same time, the average rate for a 30-year fixed mortgage was 0.65% higher at 3.34%. We expect to see a continuation of these record-low ARM rates in 2013.
Definition: The 5/1 hybrid ARM is the most popular of the adjustable-rate mortgages. This is a loan that starts off with a fixed interest rate for the first five years. After that, the rate will adjust every year, as indicated by the number ’1? in the name.
According to Freddie Mac, “the interest rate [on a 5/1 ARM loan] may jump as much as five percentage points on the fifth anniversary.” This makes it a popular product for borrowers who plan to have the loan for five years or less. Conversely, that same feature brings uncertainty for borrowers who hold the loan beyond five years.
Next in popularity are the 3/1 and 7/1 hybrid ARMs. These loans start with a fixed interest rate for three or seven years, respectively, after which they adjust annually.
The average interest rate for an adjustable-rate mortgage (ARM) loan is typically lower than that of a fixed-rate mortgage. This is what lures borrowers toward the adjustable products in the first place. But the difference, or ‘spread,’ between the two changes over time.
For instance, the market survey for December 6, 2012 showed a 0.65% spread between the 30-year fixed mortgage and the 5/1 ARM. In July of last year, the spread was twice as large at 1.30%. A larger spread brings the potential for bigger savings, for those borrowers who choose adjustable over fixed.
The Rise and Fall of the ARM Loan
In June 2004, when the housing boom was in full swing, adjustable-rate mortgages accounted for 40% of all home purchases. Borrowers used ARMs to reduce the size of their monthly payments. Lenders used them to attract more borrowers and therefore generate more profits.
Then came the housing crisis. The ARM loan’s market share fell to just 3% in 2009, after the market collapsed.
In their November 2012 Economic and Housing Market Outlook, Freddie Mac predicted a gradual rise in the use of ARM loans. By the end of 2013, adjustable loans could account for 14% of home-purchase mortgages, by their estimation.
Why the huge swing? In a word, risk. Adjustable mortgages are less certain than their fixed-rate counterparts. They can, and usually do, cause the borrower’s monthly payments to grow over time. This wasn’t a major concern during the head-in-the-sand days of the housing boom, when many people thought home values would go on rising forever.
But much has changed since then. We have all heard the stories, real or exaggerated, of homeowners who saw their monthly payments double or triple as their ARM loans reset to higher rates. Many home buyers have become ‘ARM shy’ as a result of those stories.
But the adjustable-rate mortgage is making a comeback. According to Frank Nothaft, chief economist at Freddie Mac: “We are expecting ARMs to gradually gain back some favor with mortgage borrowers rising to a 14 percent share of the home-purchase market in 2012.”
Why the comeback? Maybe home buyers are starting to realize that ARM loans aren’t inherently evil. Maybe they’ve forgotten about the housing crash. Or maybe it’s just those incredibly low rates.
The bottom line is this: The 5/1 ARM loan has some very real benefits. It generally carries a lower interest rate than the 30-year fixed mortgage. But it also carries certain risks for the borrower. You know the rate will adjust at the five-year mark, but you don’t know exactly how it will adjust.
To learn more about the pros and cons of these loans, check out the following tutorials:
- Adjustable versus fixed-rate mortgages
- ARM loan fact versus myth
Low Mortgage Rates Expected in 2013
The Federal Reserve recently announced they will be purchasing more mortgage-backed securities (MBS). They also plan to keep the federal funds rate near zero through 2015. These and other factors will put downward pressure on home loan rates in 2013. As a result, many have predicted that the benchmark 30-year rate will remain below 4% for most of next year.
We expect 5-year ARM rates to fluctuate between 2.65% and 2.85% for the first half of 2013, with a modest rise beyond that. In fact, it’s possible that we may see some additional record lows in 2013, as we did over the last few weeks. And that brings us to the obligatory disclaimer.
Disclaimer: This story contains forward-looking statements about mortgage rates in general, and the 5/1 ARM loan in particular. These projections were made based on current trends and data, and may change over time. We make no guarantees or assertions about future rates and conditions within the lending industry. This information has been provided for educational purposes only.
Mortgage interest rates edged higher from record lows this week, with lenders offering the 30-year fixed loan to solid borrowers at an average of 3.34%, Freddie Mac said in its latest survey.
Freddie Mac said the typical rate for a 15-year fixed loan was also slightly higher at 2.67%. The starting interest rates on variable home loans were slightly lower.