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Interest Only ARMs All the Rage

A look at today's most popular ARM programs

September 24, 2003


When interest rates go up the ARMs come out.

With the recent rise in interest rates borrowers are looking to escape the growing cost of fixed-rated loans. And, according to interviews with lenders, that means consumers are seeking adjustable-rate mortgages.

"When long term interest rates rise relative to short term rates, consumers choose more ARMs," Frank Nothaft, chief economist at Freddie Mac, said in an interview. "Fixed-rate credit is more expensive than adjustable rate credit."

Ten to 15 years ago consumers had few choices when it came to ARMs, also known as adjustable rates mortgages. About the only product on the market was the 1-year adjustable rate mortgage, Nothaft said.

"That's no longer the case," he said.

Today there are an array of ARMs loans available over longer periods of time, as much as 10 years with some loans, he said.

Among the most popular products are hybrid ARMs "that provide some of the benefits of fixed rates as well as adjustable rates," Nothaft said.

The loans offer fixed rates for 3, 5, 7 or even 10 years with an initial rate lower than on a 30-year fixed rate mortgage and are designed for "consumers looking for safety with a fixed interest rate the first few years," Nothaft said.

But in today's market representatives from some of the nation's leading mortgage lenders say all the rage among adjustable rate products is interest only ARMs.

Many interest only loan borrowers plan to live in their homes for 10 years or less. The loans offer lower payments than a traditional mortgage because none of the monthly payment goes toward paying down the principal -- it all goes to interest.

Wells Fargo is currently offering a 3.5% interest only loan compared to the 30-year fixed rate of 6.4%, said Sharon A. Decker, Wells Fargo area manager for Louisville, Ky., and southern Indiana.

"Our most popular (ARM product) is our interest only loan," Decker said in an interview. "What's great when you think about this mortgage is that it reduces the monthly payment and allows the buyer to buy more home ... because on interest only loans there is a considerable difference in monthly payments."

Interest only loans have been popular in western states such as California and Arizona but only now are catching on in places elsewhere in the country, including the Midwest, Decker said.

But with more buyers interested in ARMs, more consumers are gravitating toward the interest only loan, said Vijay Lala, senior vice president of product development for Countrywide Financial.

"We've seen that migration happen over the last year," Lala said in an interview. "A lot of borrowers are becoming familiar with ARMs and understand the risk of them. Plus, there are a lot more choices than during the 1990s, he said.

Countrywide is seeing a lot activity with its 3, 5, 7 and 10-year interest only ARMs, Lala said, particularly among buyers who plan on moving in five to seven years.

"They want the lowest payment they can during that period," he said. "and (interest only loans) help the borrower keep payments relatively low. And they can actually get more of a house because the payments are so low as long as they qualify for the loan."

Wells Fargo's Decker said the "traditional adjustable rate mortgage" know as the 5/1 is also popular. With that loan the rate stays fixed for five years and goes to an adjustable rate after the fifth year, she said.

The Veterans Benefits Administration will begin offering a hybrid ARM on Oct. 1 as part of a two year demonstration project, according to an announcement from the federal agency.

"Hybrid ARMs will specify an initial rate of interest that is fixed for a period of at least three years," the VA said in the statement. "After that the rate can be adjusted annually. Annual adjustments are limited to one percent, and the maximum increase in the interest rate over the life of the loan is capped at five percent."

Patrick Crowley is a political reporter and columnist and former business writer for The Cincinnati Enquirer. Email Patrick at: [email protected]

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