Adjustable rate mortgages lose their luster

Tue Jan 15, 2008 2:02pm EST

WASHINGTON Jan 15 (Reuters) - New adjustable rate mortgage borrowers are getting a smaller interest rate break than borrowers did a year ago as lenders raise the price on products that helped fuel the recent housing boom, data released on Tuesday indicates.

Starting rates for ARMs in mid-December were close to or above year-ago levels, according to mortgage company Freddie Mac, even though the Federal Reserve's target interest rate was 4.25 percent compared with 5.25 percent at the end of 2006.

"Disruptions in the capital markets beginning in August and an increase in delinquencies on ARM product has led to a sharp decline in interest-rate discounting and a tightening of credit underwriting on ARMs in recent months," said Frank Nothaft, Freddie Mac chief economist. "A year ago, the initial-rate discount on the popular 3/1 and 5/1 hybrid products was about 1.8 percentage points," said Nothaft, referring to ARMs that reset after three or five years. "In our latest survey, the rate discount had virtually disappeared on these products." Regulators have also insisted that lenders hike the initial interest rate, often known as a "teaser-rate", of new mortgages to keep borrowers on a steady repayment schedule. During a five-year run-up in home values that ended in 2005, many borrowers took out loans with low initial payments that ballooned later in the life of the loan.

ARMs accounted for 17 percent of loan applications in October 2007. In 2004, ARMs hit a high of 33 percent of mortgage loans.

"Consumers respond to changes in the relative cost of different loan products. As ARMs became more expensive relative to fixed-rate loans during the closing months of 2007, the ARM share of lending declined," explained Nothaft.

(Reporting by Patrick Rucker; Editing by Andrea Ricci)

((patrick.rucker.reuters.com@reuters.net; +1-202-310-5474; Reuters Messaging: patrick.rucker@reuters.net))

,t Keywords: USA SUBPRIME/ARMS

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