EXTRA CREDIT: Borrowers Tiptoe Back Into Exotic Mortgages
September 01 2009 - 3:23PM
Dow Jones News
Borrowers are starting to tiptoe back into more exotic
mortgages.
A flood of bad press and a collapsing housing market scared
borrowers away earlier in the year, but the latest data show that
may be reversing. Borrowers are beginning to show interest in
mortgages that combine elements of fixed-rate and adjustable-rate
mortgages known as hybrid ARMs.
Hybrid ARMs offer a fixed interest rate for a set term - usually
five years - and then "reset," after which the interest rate is
tied to a market-based floating rate and adjusted every six months
to a year.
At current rates, loans can shave as much as 1 percentage point
off a borrower's interest rate for years, potentially saving
thousands of dollars.
Those savings appear to have eliminated some of the stigma that
was attached to these non-conventional mortgages. According to
Barclays Capital, some 10% of mortgage applications for the week
ended Aug. 21 were for adjustable rate mortgages, up from a nadir
of less 2.2% for week ended Dec. 26, 2008.
Adjustable rate mortgages have come under scrutiny since the
collapse of the U.S. housing market because they can be attractive
to shakier borrowers who want a lower payment, but who can't afford
a house in the long run when the rates reset.
"I didn't sell [hybrid ARMs] to many people because a lot of
them aren't savvy enough to deal with it. I didn't want to be
responsible for someone getting underwater or getting put out of
their home," said independent mortgage broker Daniel Bell of
Richmond, Va.
However, for more financially sophisticated borrowers, these
mortgages can be a sensible option.
Bell himself has a hybrid ARM mortgage. "It worked fine for me
because my interest rate [now] is 4.5%."
As recently as early May, few were interested in hybrid ARMs.
Rates had come down on fixed-rate 30-year mortgages so sharply that
getting a hybrid ARM was actually more expensive, even in the short
term.
Now that has reversed. Freddie Mac's (FRE) most recent survey
shows hybrid ARMs with five years before the first reset are
offered at 4.67%, while fixed-rate mortgages are at 5.14%.
The rates would be even more attractive at the lenders which
specialize in the hybrid ARM business, said Art Frank, head of
mortgage research at Deutsche Bank. The difference can be as much
as a whole percentage point, pushing the ARM rate even closer to
4%.
Issuance of bonds backed by hybrid ARMs by government-sponsored
mortgage giants Fannie Mae (FNM) and Freddie Mac has jumped as
well, hitting $4 billion in July.
In August, $2.9 billion were issued, according to Barclays, and
80% were new loans. That's well below the $19 billion or $20
billion a month that were issued in the boom years, but much more
than earlier this year.
Barclays analysts Derek Chen, Nicholas Strand and Wei-Ang Lee
said they expect issuance to rise to $5 billion to $6 billion a
month in the near future.
Investor appetite for the new hybrid ARM-backed securities has
been high, thanks to their relatively high yield.
According to ARM trader Jesse Litvak of Jefferies & Co., the
bonds are trading at 105 or 106 cents on the dollar - more than
their principle value - and demand hasn't slackened.
The only hold-up seems to be the borrower - who is still a
little shy.
(Andrew Edwards covers mortgages and distressed debt for Dow
Jones Newswires and can be reached 212-416-2228 or
andrew.edwards@dowjones.com.)
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