With purchases currently dominating refinancings, ARMs are moving into the purchase market in a big way, affecting turnover projections, analysts said.
JPMorgan Securities believes that the choice to move into hybrids is more a purchase issue rather than a refinancing issue. In 2003, the hybrid ARM share - though considerable for a refinancing wave - was roughly 20%, which remained consistent with its market share. The majority of refinancings are from fixed-to-fixed or ARM-to-ARM. But there seems to be a considerable shift to hybrids on purchases, which means turnover from fixed-to-ARM is a lot more common compared to refinancing from fixed- to-ARM.
Because most hybrids are retained by bank originator portfolios, JPMorgan said that there are usually only a few "no cost" hybrid refinancings. The high prepay rate on hybrids has pushed originators that hold the loans to require upfront payments for the originations. This means either out-of-pocket expenses for the borrower refinancing or a higher balance on the new loan. In contrast, fixed-rate closing costs for a refinancing are more often absorbed in the rate given that the loans are sold. This is why fixed-rate borrowers who are refinancing and who have relatively short horizons will likely remain in a fixed-rate product, as the breakeven period prior to moving is immediate for a no cost refinancing. In comparison, for an ARM with an upfront refinancing cost, the breakeven could be several more months despite the lower monthly payment.
For a purchase, closing costs are less relevant because horizons are usually relatively longer. This is why it is not surprising that ARMs are a more popular vehicle for financing purchases. This has lessened lock-in despite a 100 basis point rise since last year. A homeowner who has a fixed-rate loan who either wants to trade up or needs to move is not really meaningfully limited by interest rate levels. Affordability is maintained through the ARM sector.
One mortgage analyst said that affordability issues are driving the higher proportion of ARMs in the purchase market compared to refinancings - ARMs make up 30% to 40% of all refinancing transactions while comprising more than 50% of all purchase transactions.
"We're seeing a very stretched market right now, especially in certain parts of the country like California," said the analyst. "It has become a way for people to manage their monthly payments." He noted that this also explains the current popularity of the IO product.
It has also become a low LTV market because people have considerable profits to turn over into buying homes. However, they have problems managing the payments and purchasing a home by taking an ARM allows these borrowers to do so. He noted that this is possibly one of the reasons why there has been more refinancing activity in conforming ARMs compared to the jumbo market. "The high home prices in many parts of the country makes the purchase market almost exclusively jumbo," said the analyst, while the refinancing transaction is not skewed toward higher balances.
Although it costs more to price in a zero-point rate versus a one-point rate, the analyst said that many of the large bank originators were out very aggressively pushing no cost ARMs during the refinancing wave in March. This is because the banks holding these mortgages in portfolio don't have to be as price sensitive as mortgage bankers who sell into the secondary market, said the analyst.
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