Home Prices Drive Buyers to Adjustable-Rate Loans

Gains in U.S. home prices have spurred consumers to opt for adjustable-rate mortgage loans, traditionally a popular loan product in a high-interest-rate environment, at a time when borrowing costs are near historic lows.

Adjustable-rate mortgage loans, or ARMs, have allowed home buyers to qualify for larger loans. This ability to buy a house for what initially is a lower monthly mortgage rate has helped boost home sales and prop up an economy smarting from the slowdown.

“Rapidly increasing home prices are driving people to adjustable-rate mortgages for an initially lower monthly payment,” said David Beadle, a Milford, Mass.-based mortgage lender.

In Southern California, the percentage of borrowers using adjustable-rate mortgages has edged up over the last year, but remains far below record-high levels.

In Los Angeles County, more than 22% of home buyers used adjustable mortgages, and 24% in Orange County in February, the most recent data available from DataQuick Information Systems Inc. The peak, in the mid-60% range, came during 1994 in both counties.

In the Southland, “we’re starting to see more of a trend toward adjustable-rate loans,” said Lenny McNeill, a regional sales manager for lender Washington Mutual Inc.

Borrowers “can qualify for more house because they qualify for a lower interest rate,” said Vijay Lala, who heads product support at Countrywide Home Loans, a unit of Calabasas-based Countrywide Credit Industries Inc.

“They do help people afford housing better. It can help you get into your first home,” said Stephen LaDue, president of Affiliated Mortgage & Financial Corp., a Wauwatosa, Wis.-based lender. “It helps some people who are marginal borrowers get more house for their loan.”

Mortgage rates for ARMs are initially lower than for their fixed-rate counterparts. When a borrower gets an ARM, he or she will pay a lower monthly mortgage rate for a set period.

After this period, the loan rate floats with an extra margin--usually 2.75%--over a benchmark borrowing rate used by banks and lenders such as Libor, or the London Interbank Offered Rate.

After the initial three-to-five-year period, borrowing costs rise annually because rates on these adjustable loans ratchet above the loans’ benchmark rate. In a rising-rate environment, that means borrowing costs could rise every year until reaching a preset cap such as 12%.

In a declining-interest-rate environment, rates for consumers with ARM loans could fall. But loan agreements often limit the drop in mortgage rates in such an environment.

For a home buyer looking to borrow $100,000, the monthly cost associated with a 30-year fixed-rate loan on which a borrower pays two points at 6.75% is $648.60.

If someone opts for a one-year ARM with 2% of the loan amount paid upfront to get a 5.50% monthly rate, the monthly cost would total $567.79.

The cost savings become more meaningful when the loan amounts increase, as they have recently because of gains in home prices.

This is particularly true in California, where housing affordability is dropping as home prices climb. Only 31% of the state’s residents can afford a median-price home, which costs $267,000 in Los Angeles County. Nationwide, the rate is 57%.

Bond traders expect the Federal Reserve to raise rates later this year. With the economy expected to be sluggish in the near term, short-term Treasury rates are low.

But long-term rates have risen on expectations the Fed will eventually raise rates and the U.S. economy will pick up steam.

“Short-term rates have not moved much. Fixed-rate mortgages have jumped, while ARMs haven’t moved much. Therefore ARMs look attractive,” said Beadle, the Massachusetts mortgage lender.

Weighing these short- and long-term borrowing costs becomes more important when one considers that home buyers are more peripatetic than ever.

“We are a mobile society. We constantly move. The majority of 30-year loans are paid off by five years or seven years,” said Affiliated Mortgage’s LaDue.

“The ARM loan is a better deal to get a lower interest rate. I do that analysis every day for customers.”

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Times staff writer Daryl Strickland contributed to this report. Reuters was used in compiling it.