Consumers saying farewell to ARMs as rates surge

NEW YORK (Reuters) - Consumers are shunning adjustable-rate mortgages in droves as rates surged to levels not seen in over six years, data from an industry trade group showed on Wednesday.

The Mortgage Bankers Association said borrowing costs on 30-year fixed-rate mortgages dropped to the lowest level in weeks, but rates on one-year adjustable-rate mortgages (ARMs) surged to 6.51 percent from 5.84 percent in the week ended August 24, its largest weekly jump on record and highest level since January 2001.

The ARM share of activity decreased to 15.0 percent, down from 18.6 percent the previous week, its lowest level since July 2003 and in stark contrast from where it hovered during the U.S. housing market's heyday at above 30 percent.

Jim Baird, chief investment strategist at Plante Moran Financial Advisors in Kalamazoo, Michigan, said the decline in ARM share indicates that borrowers are becoming increasingly shrewd about their mortgage options.

"A decline in the adjustable-rate mortgage share of activity would tend to suggest a greater degree of caution on the part of consumers," he said.

U.S. mortgage applications fell for a second consecutive week, reflecting a drop in demand for home purchase and refinancing loans.

"Another factor is that the comparative difference in rates between adjustable and fixed rate products is significantly diminished making adjustable rate products much less attractive than was the case a few years ago," he said.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, for the week ended August 24 decreased 4.0 percent to 615.2.

Applications, however, were 10.5 percent above their year-ago level. The four-week moving average of mortgage applications, which smoothes the volatile weekly figures, was up 0.3 percent to 647.9.

Borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 6.41 percent, down 0.08 percentage point from the previous week. Interest rates were above year-ago levels at 6.39 percent. Fixed 15-year mortgage rates averaged 6.10 percent, down from 6.20 percent.

TIGHTER LENDING STANDARDS STIFLING

A sharp rise in defaults in the subprime mortgage market, which caters to borrowers with poor credit histories, has caused lenders to tighten requirements, making it difficult for those with weak credit to get a home loan.

"As lending standards continue to tighten up for those seeking to buy or refinance, it's not surprising that we've now seen two straight weeks of declines in mortgage application activity," said Plante Moran's Baird.

The MBA's seasonally adjusted purchase index fell 4.0 percent to 424.0. The index, however, was above its year-earlier level of 375.9, a rise of 12.8 percent.

The group's seasonally adjusted index of refinancing applications dropped 4.2 percent to 1,729.6. The index was up 7.5 percent from a year ago when the index stood at 1,609.2.

The refinance share of applications increased to 40.4 percent from 39.9 percent the previous week.

"We expect continued softness in housing, but the silver lining may be a return to more rational decision-making for home buyers once we get through this downturn," he said.

U.S. housing industry indexes, in general, tend to be volatile, but recent data paint a poor picture and suggest a delayed recovery for the hard-hit sector.

The MBA's data may be overstating activity since it includes only retail lenders, which possibly may be experiencing an increase in applications as wholesale lenders pull back from the market, Michelle Meyer, an economist at Lehman Brothers in New York, said in commentary published Wednesday.

The MBA's data does not cover mortgage brokers, major participants in the loan origination market.

The MBA's survey covers about 50 percent of all U.S. retail residential loans. Respondents include mortgage banks, commercial banks and thrifts.