As with many comebacks, fame for the adjustable-rate mortgage proved fleeting.
Last year, adjustable loans caused quite a stir. Consumers in the market to buy a home or refinance a mortgage panicked as rates shot up on fixed loans. Suddenly, adjustable mortgages with low introductory rates started looking good.
But as rates on fixed loans peaked, then came down slightly, consumers have hardly looked twice at the alternative product.
In fact, lenders say, a borrower taking a fixed loan today might find himself better off than someone who'd taken an adjustable loan awhile back.
For one thing, the gap has narrowed between interest rates on fixed loans and on ARMs -- which typically start low and can increase 2 percent a year and 6 percent over the life of the loan.
When an average rate on a 30-year, fixed loan was at 8.39 percent the week of April 28 last year, the average starting rate on an ARM was 5.05 percent, a spread of more than 3 percent. As the Federal Reserve system raised short-term interest rates six times in 1994 to curb inflation, rates on 30-year loans continued to rise, peaking at 9.41 in mid-December.
But by last week, the average rate on 30-year, fixed loans had dipped to 9.06 percent, according to HSH Associates, a New Jersey-based firm that tracks mortgage rates. Meanwhile, the average ARM rate rose to 6.86 percent.
"We don't find as many people are as attracted to conventional ARMs," said Kathy Malone, assistant vice president and branch manager of Countrywide Home Mortgage Loans in Ellicott City. She added, though, that ARMs insured by the Federal Home Administration have retained their popularity, as they typically increase no more than 1 percent per year.
Last year, conventional adjustable-rate mortgages "rocketed to the forefront because the gap was so wide, it was hard to ignore them," said Keith Gumbinger, of HSH Associates. "ARM [rates] have been trending upward in general for the entire year. The gaps have narrowed pretty sharply as lenders have been forced to price their one-year ARMs more expensively and there has been downward pressure on fixed rates. The gap should continue to narrow."
Starting rates on ARMs will likely rise slightly above 7 percent, as banks' cost of borrowing money rises, Mr. Gumbinger said.
Even if rates remain stable, borrowers of adjustable mortgages can expect their rates to rise the maximum 2 percent per year. For instance, a borrower of an ARM with a starting rate of 4.25 percent, with an increase to 6.25 percent this year, could expect his rate to go to 8.25 percent next year.
Such increases can make all the difference to borrowers choosing between fixed and adjustable loans, especially when adjustables could end up close to or higher than a fixed rate loan after a year.
"Consumers typically want to see they'll win for at least the first two years," said Ken Sonner, vice president of North American Mortgage Co. in Columbia.
"With less than a 2 percent spread, it isn't advantageous to take an ARM," Mr. Sonner said. "As long as interest rates are in single digits, it makes sense to continue to take fixed rates."
In December, ARMs accounted for more than half of all loan originations, according to the most recent figures from the Federal Housing Finance Board.
But many in the industry expect that share to shrink, with more borrowers going for fixed-rate loans. Those that stay with adjustables will probably favor loans known as 10-1 adjustables or 7-1 adjustables. Such loans offer a lower starting rate for a period of either 10 or seven years, before reverting to a one-year adjustable loan.
The shrinking market share will by no means make ARMs obsolete. Good deals in ARMs are still to be found, lenders said.
ARMs still are more affordable than fixed loans for many first-time home buyers, Ms. Malone said. The 2 percent spread between rates on fixed and adjustable loans could mean a difference of $167 a month, for instance, on a $100,000 loan, she said.