This week, Freddie Mac, released its 21st annual survey of Adjustable Rate Mortgages (ARMs). The survey, conducted from December 20 to December 23 among 100 ARM lenders, had three major findings:

Lenders are giving greater discounts on introductory ARM rates; ARM customers are garnering decreasing savings relative to fixed rate loans; 'Hybrid' ARMs such a 3/1 or 5/1 loans are increasingly popular with borrowers.


Frank Nothaft, Freddie Mac's chief economist noted that the Federal Reserve had increased short term interest rates five times over the second half of 2004, but that this had had little effect on long term mortgages. 'ARMs, however rose by about 40 basis points over the course of the year because they are typically priced off of financial instruments with shorter maturities that match the length of the initial adjustment period.'

The starting rates for adjustables would have been higher, he said, if lenders had not widely offered initial rate discounts to borrowers. At the beginning of the year, this discount averaged about 0.375 percent for one-year ARMs but by the end of the year was averaging 1.34 percent. However, this discount is still below the 1.7 percent average in the 21 years tracked by Freddie Mac.

However, compared with the 2003 survey, the interest rate saving is now smaller, even with the discounts. A one-year adjustable in 2003 averaged a rate 2.0 percent below a 30-year fixed rate but was only 1.6 percent lower in 2004.

According to Nothaft, when the spread between 10-year and 1-year Treasury notes (constant maturity yields) is steep, ARMs become more popular among borrowers. The spread started off the year at 2.91 percentage points and ended around 1.57 percentage points, and the ARM share of mortgage originations peaked at 40% in June immediately after the year's peak spread of 2.94 points in May.

Hybrid ARMs have continued to grow in popularity. Since 2002 they have accounted for the majority of purchase-money ARMs. Those carrying an initial fixed rate period of five years with one year adjustments thereafter (5/1 ARMs) are the most popular product. While these loan types may carry dramatic rate increases at the end of the initial period (as much as 5%), they make sense for many home buyers. National statistics indicate that first time buyers stay in that home for less than five years.

The survey showed the following averages for 1, 3, 5, 7, and 10 year adjustable arms. Figures are for the fully-indexed rate, the initial period discount, and the resulting initial interest rate. All loans are conforming.

Initial Adjustment Full Index Initial Discount Initial Interest Rate
One Year 5.51 1.34 4.17
Three Year 5.57 1.10 4.90
Five Year 5.47 0.48 5.33
Seven Year 5.47 0.14 5.33
Ten Year 5.48 0.07 5.40


Freddie stated that the savings for borrowers opting for a Treasury-indexed ARM with a 30-year amortization and a loan amount of $175,000 can expect initial savings (up to the first rate adjustments) of:

1 year conforming 2,022
3/1 ARMS 3,329
5/1 ARMS 4,973
7/1 ARMS 3,881
10/1 ARMS 4,498


While those total savings amounts look attractive, over the lifetime of the first adjustment period they are not substantial (37.50 a month for a 10/1). With fixed rate mortgages running around 5.81 percent at this time, the longer term adjustables, where lenders are, understandable offering lighter discounts, are probably not going to have much popularity with borrowers.