Adjustable Mortgages Appear Stuck on High : Homeowners With ARMs Wonder Why Rates Aren’t Declining at Same Pace as Fixed Loans
When interest rates on new fixed-rate mortgages began hitting 10% and lower earlier this year, Anadelle Johnson thought that the rate on her adjustable-rate mortgage, which was at 13.28% in December, 1984, should have dropped to single-digit levels too. But to her dismay, Johnson’s rate went only to as low as 11.27% in January.
“I was disappointed that it did not go down faster,” said Johnson, 35, a Castro Valley, Calif., medical-products company supervisor. Frustrated, she and her husband refinanced their loan, obtaining a new mortgage at 10%.
Johnson is one of thousands of homeowners who have been surprised, disappointed, confused and upset that rates on their adjustable-rate mortgages have not declined as fast or as far as they hoped. Despite recent sharp declines in overall interest rates, rates on many of these mortgages have fallen only slightly, if at all. In some cases, the rates have actually risen.
California Picture
The complaints appear to be particularly acute in California because a higher proportion of this state’s homeowners have adjustable-rate mortgages than the national average. What’s more, rates on California ARMs tend to move much slower than those elsewhere in the nation because they are pegged to an index that is less volatile.
The confusion and complaints are seen as a major reason for continuing consumer disenchantment with adjustable-rate mortgages. With single-digit interest rates on fixed-rate mortgages available for the first time in nearly eight years, three out of four consumers buying homes today nationwide are choosing fixed-rate mortgages, compared to less than half in 1984.
Homeowners unhappy with how slowly their ARM rates are declining are refinancing them into fixed-rate mortgages. In many cases, they can get lower rates on fixed-rate loans than they have on their current ARMs. Usually, for new loans, ARM rates are from 1 to 2 percentage points below fixed-rate mortgages.
Leslie Heublein, a 31-year-old Diamond Bar accountant, said she and her husband are refinancing their ARM, now at 10.5%, into a 9.75% fixed-rate loan. “I’m going to be saving a considerable amount by refinancing,” she said. “Plus, I won’t have all that uncertainty for the next 20 or 30 years.”
“If rates were going down faster on ARMs, there would likely be renewed confidence in ARMs” and refinancings would not be as attractive, said Richard J. Rosenthal, a Los Angeles realtor and president of the California Assn. of Realtors.
The disenchantment with adjustable-rate mortgages may make it harder for savings and loan firms to make them in the future, some analysts say. And that could hurt the S&Ls;, particularly California firms, some of which make only adjustable-rate mortgages. Those institutions abandoned fixed-rate mortgages in the early 1980s because of the risk that rising interest rates would make the loans unprofitable.
Protection Cited
Lenders and regulators, for their part, acknowledge that many ARMs are not declining as quickly as overall mortgage rates. But they say that the index’s stability generally is good for consumers because when overall interest rates rise, ARM rates will not rise as fast. The protection from payment increases is more valuable than the benefit from payment decreases, they argue.
“Borrowers should be more concerned about the risks that they will not be able to make payments if rates rise,” said Ian Campbell, spokesman for Los Angeles-based Great Western Savings, one of the nation’s largest home lenders.
They also say the complaints are due more to consumer confusion and misunderstanding than to lender abuse. Lenders, they say, are simply following the terms of their contracts and the vast majority of consumers were made aware of these terms when they took out the loans.
‘Short Memories’
“Some people just have short memories,” said Mario Antoci, president of Home Savings of America, contending that the S&L; fully informed its customers of the lack of volatility in their ARMs. Antoci and other S&L; executives note that the problem is likely to subside if interest rates bottom out or move upward again.
“Anytime you have an environment when rates are going down, people are going to start questioning why their rates are not going down as fast as they want,” said David Meders, head of consumer affairs for the San Francisco branch of the Federal Home Loan Bank, which regulates the S&L; industry. Meders estimates that consumer complaints to the agency are running 10% above normal.
The new round of consumer complaints is the latest in a series of problems that has plagued ARMs since their introduction in 1981. S&Ls; and other lenders--particularly in California--have aggressively marketed the loans to shift all or part of the risk of rising interest rates to borrowers.
‘Teaser’ Rates Hit
But lenders have been criticized for offering artificially low, introductory “teaser” rates that, critics say, induced unqualified borrowers to take the loans. Other critics have complained about the lack of uniformity in the terms of the loans, which makes it hard for consumers to compare different loans. Still others have accused lenders of misleading or inadequate disclosure of loan terms. These and other problems have sparked several lawsuits against California lending institutions, as well as moves in the state Legislature and Congress for greater regulation.
The latest spat centers around the heavy use in California of an ARM index that moves more slowly than overall interest rates.
Most of the nation’s ARMs are tied to one-year Treasury bills, which tend to move equally along with general interest rates. But rates on most California ARMs are pegged to an index determined largely by rates that savings and loan associations pay on savings deposits.
Monthly Index
That index, called the 11th District cost-of-funds index (the 11th District includes S&Ls; in California, Arizona and Nevada) is calculated monthly by the Federal Home Loan Bank of San Francisco. S&Ls; and others typically tack on a profit margin of between 2 and 3 percentage points to that index to determine the actual rate that borrowers pay.
California S&Ls; use this index more than others, partly out of tradition, said Don Alexander, spokesman for the Federal Home Loan Bank of San Francisco. In the mid-1970s, state-chartered California S&Ls; were allowed to offer a forerunner of the ARM, called the variable-rate mortgage, making California one of the first states to allow a non-fixed-rate mortgage.
State law, however, required that rates on these variable-rate mortgages be tied to an 11th District cost-of-funds index calculated semiannually by the Federal Home Loan Bank of San Francisco. Many of these S&Ls; have simply continued using the cost-of-funds index, now calculated monthly, for their ARMs, Alexander said.
Unique Situation
Also, he said, most of the other 12 regional Federal Home Loan Banks do not calculate a similar cost-of-funds index for their own regions, although a national cost-of-funds index is computed by the Federal Home Loan Bank Board.
The index derives its stability from the fact that S&Ls; change their savings deposit rates relatively infrequently. “When overall interest rates fall, ARM rates will not fall as rapidly; but when rates rise, they will not rise as rapidly,” said Thomas Lawler, economist for the Federal National Mortgage Assn.
And that, generally, has been the case. In September, 1984, for example, the cost-of-funds index stood at 11.04%, its highest level in the last three years. The one-year Treasury bill rate then was higher, at 11.58%.
Falling Rates
Since then, the cost-of-funds index had fallen to 8.96% as of February (the latest month for which it has been calculated), while the one-year Treasury rate had dropped even more, to 7.61%.
And in 1981, when rates on one-year Treasury bills topped 16% briefly, the cost-of-funds index never went above 12.5%.
“The safest index is the cost-of-funds index,” Home Savings’ Antoci said.
However, critics like Rosenthal of the California realtors group say that, in practice, ARMs tied to the cost-of-funds index have tended to rise much faster than they have fallen.
One reason for the upward bias, critics say, has been that some ARMs apply a principle called “carry over.” Many ARMs are limited--or “capped”--in the amount their rate can rise in any given period. For example, some loans are capped at 2 percentage points in any year. But if the index rises more than the limit, the difference is carried over and applied in a future period. Thus, although interest rates have declined recently, rates on some ARMs have continued to rise.
Shift of Funds
Another reason for the upward bias is financial deregulation, which has allowed savings institutions to offer higher-paying money-market savings accounts and other savings products. The shift of funds from lower-paying passbook accounts into these higher-paying accounts has raised the cost of funds and forced the index higher than it otherwise would have been.
Such could have been the case in February. Despite a decline in Treasury bill rates, the cost of funds index actually went up, to 8.96%, from 8.77% in January. Joseph F. Humphrey, chief economist for the Federal Home Loan Bank of San Francisco, attributes this rise in part to a shift of deposit money from lower-paying accounts into higher-paying certificates of deposit and other accounts for individual retirement accounts.
One 57-year-old Los Angeles insurance executive was not happy about that increase. His ARM rose to 11.2% in February from 11% in January. “I just don’t think they’re playing fair,” he said. “There ought to be more protection for the consumer.”
