Saturday, February 28, 2009


Fixed rate mortgages continue to be the financing of choice, in spite of former Fed Chairman Greenspan’s attempt to sway borrowers towards adjustable rate mortgages, or ARMs. Studies from the Federal Housing Finance Board, which regulates savings and loan institutions, show that more than 80 percent of mortgages tend to be fixed-rate products versus 18 percent that are adjustable.

This puts the current adjustable rate subprime crises in proportion, since subprime loans comprise just 6 percent of outstanding mortgages, though their default rate is approaching 20 percent. The default rate for all conventional mortgages is now 6 percent.

"The fixed-rate mortgage is a cornerstone of the U.S. housing finance system and has been instrumental to the accrual of wealth on the part of many households. The low interest rates of the past two years have increasingly lured consumers seeking a predictable payment in an uncertain economy," said Stuart Gabriel, director of the University of Southern California Lusk Center for Real Estate.

The 30-year, fixed-rate mortgage is about 70 years old. The loan instrument was first offered during the 1930s after the creation of the Federal Housing Administration as part of financial reforms to combat the Depression.
Before that, most residential loans were balloons, requiring a payoff within 10 years. In addition, mortgages were made for only up to 50 percent of a property's value.

Long-term loans took off in the housing boom post World War II, when FHA and VA mortgages fueled construction in U.S. suburbs. At the same time, homeownership rates jumped once the 30-year loan became available, from 44 percent in 1940 to 65 percent in 1966; the rate is near 68 percent today.

Adjustable-rate loans have their advantages when fixed interest rates are high or rising quickly. But the subprime debacle showed us that using them when interest rates were at record lows 2003-2005, lulled borrowers into a false sense of security. The Federal Reserve under Fed Chairmen Greenspan and Ben Bernanke raised short term interest rates 17 consecutive times over 2 plus years, which burst the real estate bubble and caused the credit crunch we have today.
ARMs first became widely available in 1981, their share of the mortgage market has varied from a high of 39 percent in 1994 to a low of 12 percent in 2001, Gabriel found.

"Clearly, borrowers benefit from the availability of a wider variety of products. ARMs appeal to more mobile households, homebuyers who expect their incomes to be positively correlated with interest rate fluctuations and buyers who are down payment-constrained," Gabriel wrote. But if affordability of the monthly payments isn't a problem, "then many borrowers prefer the ongoing payment certainty of the fixed-rate loan."

There are some regional differences in the use of fixed-rate vs. adjustable-rate mortgages. Consumers in Alaska are most enamored of the fixed-rate mortgage: In 2003, 98 percent of conventional home mortgages in Alaska were fixed-rate mortgages.
Following Alaska in favoring the fixed-rate mortgage are Delaware (93 percent), Oklahoma (92 percent), Texas (92 percent), New Mexico (91 percent), Pennsylvania (91 percent) and Tennessee (90 percent.)

Homebuyers in Massachusetts are most likely to take an ARM; 32 percent did so, in part due to the higher price of homes. Other states where adjustable loans command a high percentage of the market: Colorado and Michigan, with 30 percent; California, 29 percent; and Illinois, 27 percent.

© Harlan Green

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