Adjustable-rate mortgages return with a more conservative look

With one daughter in college and another in high school, Guy Hempel and Cherina Rossi face years of tuition payments.

So the Fountain Valley, Calif., couple are betting on their house to help pay for their daughters' education.

Last month they refinanced into a new adjustable-rate mortgage, or ARM, which means they'll pay $700 a month less than they would have under a traditional 30-year, fixed-rate mortgage.

Their house payments will remain fixed for five years, and by the time those payments could adjust upward, the couple will be ready to move. "By that time, we'll be empty-nesters and won't need a big family home," Rossi said.

The change, said her husband, also means "we're saving perhaps 30 percent a month that we can put to their education."

Rossi and Hempel are part of a small but growing number of homeowners moving away from the traditional, fixed mortgages that dominated the market in the wake of the housing crash – a crash that was fueled, in part, by people borrowing with risky, adjustable home loans.

ARMs all but disappeared following the financial meltdown. But they're making a comeback.

Nationwide, adjustable mortgages made up 7.4 percent of all U.S. mortgage applications as of mid-November, up from 0.9 percent in January 2009 and 3.8 percent a year ago, Mortgage Bankers Association figures show.

Loan brokers say last summer's jump in rates for the 30-year fixed mortgage sparked much of the renewed interest in ARMs. The rates for a 30-year fixed shot up from 3.35 percent in May to 4.58 percent in August.

Borrowers realized, however, they still could get low monthly payments with ARMs, since initial rates on those loans are 1 percentage point or more lower.

"People got spoiled with (30-year fixed) rates at 3 { percent," said Alan Renteria, a co-founder of Citizens Direct Home Loans in Yorba Linda, Calif. "That's why people are going with the adjustable rate mortgage."

ARMs also help some home shoppers get a toehold in the market, allowing them to buy a house they couldn't afford with a 30-year fixed, mortgage brokers said.

"Better to get the house now before prices go up," said John Hoppe, a mortgage broker for Paramount Residential Group in Anaheim, Calif.

The use of adjustable mortgages still is well below average and remains significantly below the peak of 80 percent of loans at the height of the housing boom in 2004-05.

Some brokers think ARMs still may be too risky for some borrowers. If rates go up, many homeowners may be unable to afford those higher payments.

ARMs, for example, aren't for people planning to stay put a long time. For them, it's still better to lock in a fixed rate while interest still is near historic lows. The average rate on a 30-year fixed was 4.29 percent last week, according to government-sponsored mortgage giant Freddie Mac.

"It's still a phenomenal rate," said Paul Miller, a senior loan officer at JMJ Financial, a mortgage banking firm in Aliso Viejo, Calif. "I'm not putting a lot of my borrowers into ARMs right now because 30-year money is cheap. ... Rates have nowhere to go but up."

The California Association of Realtors, for example, forecast that interest on 30-year, fixed-rate mortgages will rise to 5.3 percent in 2014, up 1 percentage point.

Brokers say that adjustable mortgage users tend to be savvier and more willing to tolerate risk. In general, ARMs also are more common on "jumbo" loans, or loans for more than $625,500, where the rate difference is even greater. Unlike smaller loans, jumbos can't be sold to the government-backed Fannie Mae and Freddie Mac.

"It's totally up to the attitude of the client," said Paul Scheper, a division manager for Greenlight Loans in Irvine, Calif.

Today's ARMs are a far cry from the exotic, high-risk loans of the housing bubble, brokers say. In many cases, homeowners received loans with artificially low "teaser" rates that eventually adjusted to payments they couldn't remotely afford.

Owners expected rising home prices to bail them out of those loans before payments adjusted upward. But when home prices stopped climbing, the market collapsed, pushing millions of homes into foreclosure.

Today's ARMs don't include "teaser rates" and have more stringent requirements – such as minimum down payments and high credit scores. Even-tougher lending standards take effect in January.

In addition, the most common ARM today is a hybrid that combines features of both fixed and variable-rate loans, Scheper said. Loan rates remain fixed for a set period – five, seven or 10 years – then adjust once a year after that. Such loans also have a cap on yearly increases, plus an overall lifetime cap.

But when rates go up, so do payments.

Adjustable mortgages may make sense for borrowers planning to sell a home within five to 10 years, for those who can afford higher payments or for young professionals expecting to see their income grow, brokers said.

"For some, it's worth saving an extra $100 per month for five years – a $6,000 savings to play the dice," Scheper said. "The rate is lower, the payment is lower, which makes things easier on their wallet."

Savings are greater for pricier homes.

Derek Lewis estimated that he saved about $180,000 since he got an adjustable, $1.4 million loan on his Newport Beach home nine years ago, due mainly to steadily declining interest rates.

Lewis took out another ARM last month on a Costa Mesa, Calif., condo he purchased for his son and daughter-in-law to live in. The rate is 3.1 percent vs. more than 4 percent for a 30-year fixed.

"I was interested at this point in (getting) the lowest possible rates," said Lewis, 73. "There's always that risk factor for people who would be in trouble if rates went up. ... But I'm in a position now so that if rates went up five years from now, I could pay (the loan) off."

Real estate broker Mike Cocos, manager of ERA North Orange County, said he used an adjustable mortgage that's fixed for seven years to buy a home in Brea, Calif., two years ago because "money was cheap" and he could afford a bigger house using an ARM. The savings total $265 a month or $22,200 over seven years.

"I'm conserving my capital to buy real estate, and I could afford more house for the payments," he said.

"As a Realtor, I don't have a negative spin on adjustable rate mortgages," Cocos said. "They're a tool for whatever market you're in. People have to understand them and not be afraid of them."

Raj Joshi, 41, recently refinanced the loan on his Irvine home from a 30-year fixed to a five-year adjustable mortgage, cutting his monthly house payment by $450.

"We realized we don't want to live in this house for 30 years. The maximum we would live in this house is five years," said Joshi, senior manager at a pharmaceutical firm. "Taking out an ARM, you can save hundreds of dollars a month. Over a five-year period, it's thousands of dollars."

Joshi also refinanced his old home in Ventura County – now a rental – into an ARM. He plans to plow the savings into extra payments to reduce the principal. So even if rates do go up after five years, his payments will be smaller because the loan balance will have shrunk.

Guy Hempel and Cherina Rossi paid $2,800 a month when they bought their two-story, four-bedroom house in 1999. They have refinanced into a new adjustable-rate mortgage three times since then.

The fixed rate on their old loan was set to adjust a year from now. So the couple refinanced, paying just under $1,700 a month with the new adjustable-rate loan. That's about $700 a month lower than they would have paid with a 30-year fixed mortgage and $125 a month lower than their old payment.

When the five years are up, the couple said, they either will refinance their loan again or they'll sell and move.

"I think there was a time when people used their house as an ATM. I wouldn't put ourselves into that category at all," Hempel said. "We're not trying to obtain a loan for more than the house is worth. I think that's the whole crux of why the bubble happened."

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