Adjustable Rate Mortgages Are A Wise Choice for Borrowers

NEW YORK (MainStreet) — No one's satisfied with the pace of the housing recovery, but there's no doubt things are getting better. Still, a quick snap back to normal is unlikely.

"While it seems we have made our way out of the turbulent times that have bounced the market around for the last few years, there is still plenty of uncertainty ahead," says Keith Gumbinger, vice president of HSH.com, the mortgage and housing research company.

In his midyear analysis, Gumbinger says rates on 30-year fixed mortgages could edge up to 5% or 5.25% by the end of the year, from today's 4.233%. With the economy improving, the Federal Reserve will continue to wind down efforts to keep long-term interest rates down, Gumbinger says. A 5% rate would still be low by historical standards.

But the Fed will still strive to keep short-term rates down, he says. As a result, introductory rates on adjustable-rate mortgages will stay low. The widening gap between ARM and fixed-rate loans will make ARMs a wise choice for more borrowers. Hybrid, 5/1 ARMs, which carry a fixed rate for five years, then adjust to market conditions every 12 months, could charge initial rates of between 2.9% and 3.9%, he says.

Qualifying for a mortgage will not be as difficult as it was in the depths of the economic crisis, but will probably continue to be more difficult than in "normal" times, Gumbinger says. That's due partly to tougher federal regulations to ensure borrowers will be able to make their payments.

Still, he notes that a few lenders have been dipping their toes into the subprime mortgage market, which involves loans to applicants with less-than-stellar credit. A wave of subprime loans gone bad helped trigger the crisis, and it is not likely that the most toxic products, such as "liar loans" that required no proof of income, will return, he says.

Today's subprime loans require that applicants have large amounts of equity in their homes, and often charge rates two or three times those available for borrowers with good credit.

Driving this gingerly return to the subprime market is lenders' search for more borrowers, Gumbinger says. For several years, the market was shored up by the huge volume of mortgage refinancing due to record-low rates. But refinancing has fallen off a cliff in the past year or so as rates have drifted up.

"We've come through a period of time where borrowers have needed fairly pristine credentials to get access to the mortgage market, or at least access to the best possible mortgage rates," Gumbinger says. "However, that's a finite pool of potential borrowers, and a lot of them were homeowners. With refinancing falling back to more typical levels, there will be a lot of hungry mortgage lenders and investors scouring the market for business."

Gumbinger also notes that the recent rise in home prices has slowed. It is unlikely prices will rise at the double-digit pace of 2013, he says. A key reason is that tighter federal regulations will prevent the re-emergence of "affordability" products that in the past have come to market when home price gains outstripped income gains — things such as zero-down-payment loans, interest-only loans and loans to borrowers with high debt levels.

So for the rest of this year prospective loan applicants will be wise to do all they can to polish their credit records and raise their credit scores. With home prices unlikely to rise quickly, but also unlikely to fall, neither buyers nor sellers need to rush to market.

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--Written by Jeff Brown for MainStreet

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