Survey Identifies Top ARM Trends for 2014

Falling interest rates and demand for hybrid offerings were once again among the most dominant trends in the adjustable-rate mortgage (ARM) market in the last year, according to a recent survey.

Freddie Mac released Thursday the results of its 31st Annual ARM Survey of prime loan offerings, conducted earlier this month.

Collecting responses from dozens of ARM lenders, the company identified four major trends that shaped the direction of the market in the past year:

• Hybrids held on to their popularity: Lenders reported that hybrid ARMs continued to be the most popular adjustable-rate offering for borrowers, and nearly all of the ARM lenders responding to the survey offered some hybrid product. Hybrid ARMs adjust annually after starting with an extended fixed-rate period.

According to Freddie Mac, the 5/1 hybrid, which offers a five-year fixed-rate period before resetting, was the most common among borrowers, followed by the 7/1, 3/1, and 10/1. Less popular were ARM products where the repricing frequency was fixed for the entire loan life, such as the 3/3 ARM (which adjusts once every three years) and the 5/5 ARM.

• Hybrid ARM borrowers save thousands of dollars early on: As of early January, the average interest rate for a 5/1 hybrid ARM with a 30-year term was about 0.75 percentage points lower than the 30-year fixed-rate average. For a $250,000 loan, Freddie Mac estimates the monthly principal and interest payment for a 5/1 hybrid would be about $103 less than that of a 30-year fixed-rate loan over the first five years of the mortgage.

"Because consumers who choose an ARM often are taking out a higher-balance loan, their payment savings can add up over the first few years of the loan," said Frank Nothaft, VP and chief economist for Freddie Mac. The average loan size for a conventional home purchase ARM was more than $400,000 during 2014, about double the average for a fixed-rate loan.

• Treasury-indexed loans offered a lower index and higher margin than others: Of the 84 unique ARM lenders surveyed, 70 offered Treasury-indexed ARMs, while 14 offered London Interbank Offered Rate (LIBOR)-indexed ARMs, Freddie Mac reported. (However, because larger lenders are more likely to offer LIBOR-based products, those accounted for about half of ARM originations.)

Comparing the two: Treasury-indexed ARMs generally had a lower index (about 0.4 percentage points), a similar initial interest rate, and a higher margin (about half a percentage point).

• Average interest rates on ARMs fell compared to 2013: In keeping with the overall trend of mortgage rates dropping in 2014, average initial ARM rates slipped to 2.39 percent for a one-year, 2.98 percent for a 5/1, and 3.71 percent for a 10/1 Treasury-indexed ARM, Freddie Mac said.

While ARM rates have continued to fall in this year's first few weeks, borrowers shouldn't expect that to last.

"Today's low mortgage rates will not be around forever," Nothaft said, citing expectations that the Federal Reserve will raise interest rates by year-end.

However, those same forecasts also apply to fixed-rate mortgages.

"If fixed-rate loans become more expensive and home values rise further, we expect more consumers to take another look at ARMs and project the ARM share rising to 12 percent of the conventional home-purchase market in 2015," Nothaft added.