Spurred by Fed, Banks Lower Rates on Fixed Mortgages : Finance: But cost of adjustable-rate loans goes up, making them less attractive to new home buyers.

Major lenders nationwide, reacting to the Federal Reserve Board’s latest move to tighten credit, cut rates on their fixed mortgages Wednesday while raising rates on adjustable loans.

The moves, which make fixed-rate mortgages more attractive to new home buyers and to those refinancing their loans, could trigger a resurgence in the fixed-mortgage market, which had recently begun to lose ground to adjustable-rate loans.

“Fixed rates have definitely gotten more attractive in just the past week,” says Earl Peattie, president of Mortgage News Co. in Santa Ana. “If you’re going to spend some time in the same home, a fixed-rate mortgage looks increasingly viable.”

Consider what happened at San Francisco-based Wells Fargo Bank. On Wednesday, Wells Fargo cut the cost of its fixed-rate loan to 8.5% from 8.65%. But it hiked charges for a popular adjustable loan product--the so-called “one-year, T-bill ARM”--dramatically. The initial rate on this loan soared to 6.75% from 6.25% the day before.

Borrowers choose between fixed and adjustable loans based on the “spread”, or difference, between the two, experts note. That’s because the rate on adjustable loans can rise, but only by set amounts each year.

On the standard adjustable loan, the interest rate can only rise by 2 percentage points each year and by a maximum of 6 percentage points over the life of the loan. Consequently, if the start rate on the adjustable loan is low enough, the ARM borrower could save thousands of dollars during the first several years of the mortgage. If they sell or refinance within that time, they stay ahead permanently.

It was just that type of analysis that caused adjustable loans to surge in popularity during the first several months of 1994. While fixed-rate mortgages have long been the darling of home finance, adjustable mortgages snapped up more than 40% of the market by the end of May versus just 25% of the market in December.

That’s mainly because the cost of fixed loans soared during the first few months of the year, while the start rates on adjustable loans moved far less dramatically. The result: The spread between fixed and adjustable loans hit an all-time high in April, with ARMs 3.45 percentage points lower, on average, than comparable fixed-rate loans.

Even if interest rates rose as rapidly as possible, given the annual interest “caps,” ARM borrowers would pay less than fixed-rate borrowers for at least three years.

But as of Wednesday, that trend appeared to be put in reverse as lenders upped charges for ARMs and cut charges for fixed loans.

Why wouldn’t rates on both types of mortgages go in the same direction at the same time? Because adjustable loan rates are affected by swings in short-term interest rates; they’re frequently tied to one-year Treasury bills. But fixed mortgages move in concert with the long-term bond market, which is swayed by inflation fears more than current interest rates.