With adjustable-rate mortgage rates benefiting from a steep yield curve, consumers are showing increased interest in applying for ARMs as opposed to fixed-rate mortgages, and that rising interest is reflected in the issuance projections for ARM securities in 2002.
ARMs issuance is expected to exceed $100 billion this year, closely following 2001's $122 billion supply -- marking this as the second year in a row that ARM mortgage-backed securities issuance tipped over $100 billion, according to a Bear Stearns report.
Analysts said that there has been a steady rise in the interest in ARM products in the last five years and a lot of this has to do with the increasing popularity of hybrid ARMs. Currently, Bear Stearns estimates that hybrid ARMs make up roughly 75% of ARM origination. As the hybrids continue to gain more of a following, the bank expects originations to stabilize at $150 billion to $175 billion per year.
The hybrid push
Before hybrids became widely accepted, a borrower's choices were limited to either going into a 30-year fixed-rate mortgage or going into a short-reset 1/1 ARM. However, getting a 1/1 ARM - which resets every year - is obviously much riskier. This is why there have only been a few instances, such as in 1993, where a considerable number of borrowers actually got into this short, reset product.
A 1/1 ARM requires borrowers to trade off safety and the conservatism of having a 30-year fixed-rate mortgage versus. something that could change every year. With hybrid ARMs, the borrowers could choose from four different hybrid products: 3/1, 5/1, 7/1 and 10/1. This variety of options allows borrowers to tailor the products to their specific financial situation and motivation.
With many borrowers not intending to stay in their homes for more than five years, it would be better for them to get a hybrid ARM and pay a lower rate than to get a thirty-year fixed-rate mortgage that carries a higher rate.
Aside from this, since hybrids are priced off the intermediate portion to the short end of the curve, the steeper curve helps the popularity of hybrids to the extent that borrowers could get the benefit of the lower ARM rates being offered today.
Analysts have also said that the growing popularity of new ARM products, mainly hybrid ARMs, has caused the ARM market to evolve from almost purely a purchase product (which borrowers take in order to qualify for a mortgage) into a viable option for refinancings.
to conforming ARMs
The spread between jumbo fixed-rates and conforming hybrid ARMs has recently experienced a significant widening, according to a report from Countrywide Securities. However, the firm said that the spread between zero-point non-conforming and conforming fixed rates has remained rather stable in recent months.
Because of this phenomenon, jumbo borrowers who can now switch to a conforming mortgage - with the recent increase in the conforming loan limits - will currently have a greater incentive to apply for a conforming adjustable-rate mortgage rather than its fixed-rate counterpart.
Recent data from the Mortgage Bankers Association has indicated that the percentage of ARM applications in terms of dollar volume of loans has seen a significant and rapid increase.
According to Countrywide, the larger percentage of ARM applications by volume compared to the loan count, coupled with the rapid rise in the proportion of the ARM share by dollar volume, suggests that ARM applications are increasingly skewed toward the bigger loans.
"This is mostly due to jumbo borrowers with loan balances in the high $200,000 to low-$300,000 area taking advantage of the significant savings available to them in the conforming ARM market, with the most notable increase in the increasingly popular hybrid sector," said analysts.
Recent ARM activity
Though the percentage of ARM share in refinancing activity decreased to 15.5% from 16.3%, as reported in last Wednesday's MBA survey, the number is certainly higher than the 8.3% it decreased to sometime in November 2001.
However, the current percentage in ARM activity is not as great as the increase that usually occurs when the interest cycle rises significantly, when ARM share generally spikes by 25% to 30%.
According to MBA chief economist Douglas Duncan, typically the percentage of ARM activity increases when the absolute level of the thirty-year mortgage rate rises. However, this has not really happened. The other factor that causes ARM share to increase is if the spread between the thirty-year fixed rate and the ARM rate widens significantly. ARM share usually increases dramatically when these two events happen simultaneously.
The recent boost in ARM activity is mainly due to the widening of the spread between the thirty-year fixed rate and the one-year ARM rate.
Freddie Mac reported that the average one-year ARM went down to 5.04% last week from 5.12% the prior week. The spread differential between the 30-year fixed-rate mortgage (FRM), which Freddie reported to be 6.88%, and the one-year ARM decreased to 1.84% last week from 1.90% the previous week.
However, Duncan said that there is a second factor that may be causing the recent noticeable increase in ARM activity. Since there are a fair number of homes in the upper-middle and upper-income brackets that have seen significant price appreciation, people are most likely tapping into the equity in their homes. Typically, these borrowers have a higher likelihood of taking out adjustable-rate mortgages than those in the lower- and middle-income sectors.