One of this home-buying season’s hottest “new” mortgage products isn’t really new at all.
The so-called “10/1” fixed-period adjustable rate mortgage has been around for four or five years. But when mortgage rates started back up a few months ago, both lenders and borrowers began embracing the loan with a vengeance.
A fixed-period ARM is one in which the rate is set for a specified time. Then, the loan becomes an adjustable mortgage in which the rate is reset on an annual basis.
The 10/1 is one of a number of fixed-period ARMs available. There are also 3/1s, 5/1s and 7/1s.
Until now, the 10/1 was offered only by portfolio lenders or those who had special deals with mortgage conduits which buy loans and package them into securities for sale to investors on the secondary market.
But this week, the Federal National Mortgage Association, or Fannie Mae, the largest single secondary market player, said it is adding the loan to its list of standard menu items. And that means more and more lenders will be getting in on the action.
Borrowers like the 10/1 because it fits most closely with the realities of today’s housing market. Most people are living in their homes longer, so three- and five-year ARMs are just too short and 7/1s are not quite long enough.
Ten-ones aren’t priced as low as shorter-term fixed-period ARMs, so the difference, or spread, between 10/1s and 30-year fixed loans isn’t as great as it is for 3s, 5s or 7s.
For example, Countrywide Funding, which began offering fixed-period ARMs earlier this month, charges 8.36 percent for a 30-year, fixed mortgage. But for a 10/1 fixed-period ARM, Countrywide, the nation’s largest lender, wants 8.25 percent.
That’s probably not enough of a break to entice most home buyers to take a chance that rates will be lower in 10 years than they are now. But now that Fannie Mae has made the 10/1 available to all lenders, pricing should improve markedly.
The differential is already somewhat greater if you are borrowing more than $203,150. This is the “jumbo” or nonconforming portion of the mortgage market, where Fannie Mae and its sister government-sponsored enterprise, the Federal Home Loan Mortgage Corp., or Freddie Mac, are prohibited from playing and, therefore, rates are somewhat higher.
Because investors who purchase loans from lenders earn a little bit more on mortgages above $203,150, they can give borrowers who opt for fixed-period ARMs a better deal. Not as good a deal as you’d get if you chose a straight one-year ARM, but certainly better than what you’d get on a standard 30-year fixed loan.
Most mortgage market professionals believe the spread should be at least 0.5 percent for 10/1s to make sense. So let’s see what the difference would be for, say, a $220,000 jumbo loan: At 8.25 percent for a 30-year fixed loan, it would cost $1,653 a month in interest and principal to borrow $220,000. But at 7.5 percent for a 10/1, your monthly payment would be only $1,540, a difference of $113 a month. And over a 10-year period, then, your savings would amount to $13,560.
At the end of the fixed-period, you could move on. You also could move earlier, which would cut into your savings.
Or you could refinance, probably without penalty. If rates are lower 10 years down the road, you still come out ahead because the rate on your loan will be lowered accordingly.
If rates are higher, however, your rate will be adjusted upwards. But maybe not by as much as you think. Like all adjustable mortgages these days, fixed-period ARMs must come with limits on annual and life-of-the-loan adjustments.
The industry standard is 2 and 5, meaning that annual adjustments can’t rise (or fall) any more than 2 percentage points and that your rate can never go up (or down) by more than 5 percentage points as long as you hold the mortgage.
If rates 10 years from now are 2 percentage points higher, your rate will rise to 9.5 percent, and your new payment will be $1,799, an increase of $259.
If rates keep rising, your rate could go up another 2 points to 11.5 percent in the 12th year; your payment will rise to $2,087. If rates continue to go up, your 13th year payment could rise 1 more point to 12.5 percent, and your payment will go to $2,250.
