By Jeff McKinney
The Cincinnati Enquirer
Home-hungry and cost-conscious Tristate consumers faced with the prospect of rising conventional mortgage rates are turning in increasing numbers to an option once rendered almost extinct: the adjustable rate mortgage.
As mortgage rates climb from record lows recorded earlier this year, lenders report the demand for ARMs has nearly doubled. Borrowers are gambling that rates will remain somewhat low and are seizing the chance to pocket short-term savings through a myriad of ARM options.
ARMs come in many varieties, often one-year, three-year, five-year and seven-year forms. While terms vary from lender to lender, ARM interest rates typically start lower than conventional 15- or 30-year mortgages but are adjusted at a specified interval in accordance with the performance of a benchmark financial index, such as the prime interest rate. Most have caps - typically no more than 2 percentage points - on up or down adjustment within the agreed period.
According to the Mortgage Bankers Association, an industry trade group, ARMs accounted for 21.6 percent of total mortgage loans nationally in the week ending Sept 5, compared with 11.9 percent of total lending in the same period of January 2003. While a specific breakdown of the data for the Tristate area was not available, the region's largest mortgage lenders say their activity parallels the national trend.
Randy and Karen Hess, for example, opted for a seven-year ARM to finance their home, which is under construction in Liberty Township in Butler County. They got a 5.5 percent rate on a $325,000 loan through Third Federal Savings Bank. The Hesses said they preferred to lock in a 30-year, fixed loan, but balked at the 6.38 percent rate. While the size of their loan, sometimes referred to in the industry as a jumbo, and its seven-year term kept their rate well above the bargain-basement local average of 3.41 percent for a one-year ARM, the Hesses said they are happy with their decision.
"We're saving around $500 a month by going with the ARM instead of the 30-year loan," Randy Hess said. "We plan to use the extra cash to pay down the principal and the mortgage in seven to 10 years."
Around the Tristate, lenders say the rise in 30-year mortgage rates - a full percentage point since June - has triggered a rush for ARMs.
ARMs made up 17 percent of total home loans last week at Third Federal Savings and Loan in Cincinnati, one of the area's largest mortgage lenders. In contrast, ARMs accounted for only 4 percent of Third Federal's total volume in the first quarter this year.
"With the recent rise in interest rates, we're noticing that more and more of our purchase borrowers are choosing adjustable-rate mortgages rather than fixed-rate loans," said Snow Cimaglio, regional manager at Third Federal. "It seems that a lot of people who missed the lower payment earlier this year are trying to get it back with (ARMs)."
The trend also is being felt at Fifth Third, the Tristate's largest home lender. ARMs made up about 20 percent of Fifth Third's mortgage lending in May and June. But that number rose to 40 to 50 percent in July and 50 percent to 60 percent in August and September, said Joe Treinen, vice president of residential lending.
Sandy Rowe, vice president at Huntington Mortgage Group in Cincinnati, said most of the company's ARM demand has been for loans of more than $300,000. Rowe also said there has been borrower interest in balloon notes, which typically require full payment on a loan balance after a specified period, for example, five years.
The attraction of an ARM loan, lenders say, is the big reduction in monthly payments that homebuyers at least initially achieve. Borrowers, they say, increasingly are willing to gamble now and risk paying a higher monthly payment if rates move higher when the loan adjusts.
Greg McBride, a senior financial analyst at Bankrate.com, a research company that tracks rates nationally, said the monthly payment on a $150,000, ARM with a fixed rate of 5 percent for the first five years is $805.23. In contrast, the monthly payment on that same mortgage on a 30-year, fixed-rate at 6.25 percent is $923.58, a difference of $118.35. Total interest paid on the ARM during the first five years would be more than $36,000, versus $45,400 on the 30-year loan. The savings: more than $9,300.
"You can clearly see why more people would be interested in the ARM," McBride said. "It really makes a lot of sense for people who know they'll only be in the home for a certain period or a time that does not exceed the initial rate."
But buyers beware: ARMs are not for everyone and industry officials advise prospective borrowers to weigh their options carefully.
McBride said home buyers selecting an ARM over a fixed-rate mortgage based on the ARM's current attractiveness should consider the possibility that rates could rise, increasing their payments. For example, if the $150,000, five-year ARM with a 5 percent rate rose to 7 percent in its sixth year, the monthly payment would grow to $973.54 from $805.23.
"To those borrowers I would say, 'If you cannot afford a home when fixed mortgage rates are 6.25 percent, when do you expect to?'" McBride said. "Those borrowers need to look at a different house, not a different loan product."
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