ARMs Are Back as Rates Climb Higher

ARMs aren’t quite back with a vengeance; they’re more creeping in from the shadows.

Vilified for causing defaults once “teaser” rates spiked higher after 2006, ARMs fell into disuse while fixed mortgage rates plunged.

But since May the share of ARMs among all mortgages has climbed by half, thanks to a little-watched gap in how rates are rising.

As the Federal Reserve mulls slowing its monthly bond purchases, rates for 10-year U.S. Treasuries have climbed more than a percentage point between early May and July. Fixed-rate mortgages, which follow 10-year Treasuries, rose to 4.51 percent last month from 3.34 percent in January.

But ARMs follow short-term rates such as one-year Treasuries. Because the Fed will keep short-term rates very low until unemployment is 6.5 percent or lower, one-year Treasuries traded at a 0.1 percent yield recently, down 0.04 percent in the last month.

The upshot: Fixed mortgage rates have risen twice as fast as five-year ARMs since speculation about the Fed’s exit began, according to Freddie Mac data. So last week, 6 percent of mortgage applications were for ARMs, up from 4 percent in early May, according to the Mortgage Bankers Association of America.

The availability of ARMs keeps homes affordable, argues Barb Jandric, president of Edina Realty, outside Minneapolis. It’s one reason Edina didn’t see buyer interest fall as rates began rising, she said.

The more expensive the house, the likelier it will have an ARM: 14 percent of the dollar value of new mortgage requests last week were for ARMs, said Matt Robinson, spokesman for the Mortgage Bankers Association of America.

“It can mean a difference of 1.75 (percentage points) in the interest rate,” said Brian Koss, executive vice president of Mortgage Network. He estimates that 5 percent to 10 percent of his most recent customers have switched to ARMs.

ARMs aren’t for everyone. Their interest rates can rise after one, five, seven or 10 years, and the first jump can be a budget-busting 2 to 5 percentage points. They’re best suited for buyers who will move on or refinance before the rate changes, Koss said.

Even so, some lenders still advise against ARMs, arguing that fixed rates are still near multi-decade lows.

“You can’t lose sight of how amazing rates are,” said Matt Weaver, senior lender at WCS Lending in Boca Raton, Fla.

He said borrowers who keep their homes longer than expected may regret it. Depending on the product, the first jump can be either 2 or 5 percentage points. “It doesn’t warrant the risk.”

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