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Borrowers Flee from ARM Products into Fixed-Rate Loans
By Ted Cornwell
Given all the bad news about exotic, adjustable-rate loans, it is little wonder that the most recent refinancing data collected by Freddie Mac show borrowers swarming into fixed-rate loan products.
In the second quarter, 85% of borrowers who originally had a one-year ARM and refinanced chose a new fixed-rate mortgage, according to Freddie Mac. And almost the same share of borrowers with a hybrid loan that refinanced chose a fixed-rate product.
That's actually a bit lower than in the first quarter, when 89% of one-year ARM borrowers refinanced into a fixed-rate loan.
So why are ARMs losing luster with borrowers? After all, interest rates have held fairly steady and even edged down a bit in recent weeks.
Perhaps the high share of refinancing into fixed-rate loans reflects the expectation that interest rates are likely to rise. Whether or not that proves to be the case, the expectation is likely to motivate borrowers to lock-in to fixed-rate products with stable monthly payments.
Amy Crews Cutts, deputy chief economist at Freddie Mac, noted that while most borrowers who refinanced in the second quarter preferred fixed-rate loans, the spread between the average rate on one-year ARM loans and on FRMs actually widened, making the ARMs a little more attractive than before. In addition, the tightening of underwriting that is taking place in the market today may favor fixed-rate products.
"With the recent contractions in mortgage lending standards and increasing emphasis on underwriting borrowers to fully indexed rates on adjustable-rate mortgages, it is likely that we will see more demand for fixed-rate products for both new home purchases and refinance in the future," she said in a Freddie Mac news release.
Prepayment experts are starting to take a look at how the boom in nonprime ARM lending that took place in 2005 and 2006 may complicate prepayment assumptions going forward. Analysts at Andrew Davidson & Co., for instance, question how the tightening of subprime underwriting standards will affect prepayment patterns, noting that stiffer underwriting requirements may make it more difficult for subprime borrowers to refinance. Slow to stagnant home price appreciation is also adding to the lending industry's caution.
AD&Co. said the situation is causing some in the mortgage securities industry to revise their housing turnover models, because previous models have been "overpredicting the rate of housing turnover." That has made some prepay models look fast compared to the current market.
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