Freddie Mac’s (FRE) “Weekly Primary Mortgage Market Survey” and press release “30-YEAR FIXED RATE MORTGAGE RATES FALL FOR FIFTH STRAIGHT WEEK” show average mortgage rates and points:
30 Year Fixed: 5.78%, 0.6 points and fees
15 Year Fixed: 5.35%, 0.6 points and fees
5/1 Year ARM: 5.67%, 0.6 points and fees
1 Year ARM: 5.03%, 0.5 points and fees
While the government and the press are touting that the Fannie Mae (FNM) and Freddie Mac conservatorship have pushed conforming mortgages below 6%, no one is questioning why adjustable rate mortgages [ARM] still exist. I don’t believe that ARMs provide any benefits to either lender or borrower.
Lenders had the false belief that ARMs provide interest rate protection if their cost of funds increase. Even if borrowers are underwritten at the fully indexed rates, their financial behavior will still be anchored to the introductory payment. Unless borrowers are restricted from further encumbering their homes (mortgage collateral) during the life of the mortgage, the initial underwriting is meaningless. Borrowers will not be prepared for higher future payments.
Buyers falsely believed (with former Federal Reserve Chairman Greenspan’s encouragement) that it was better to pay a lower rate now than buy protection for the future. The new Fed regulations require that borrowers of high cost loans be underwritten at the full indexed rate, but that doesn’t mean they’re mature enough to handle the risk of rate increase.
Life circumstances and income changes can affect ability to pay with either fixed or variable rate mortgages. But, higher rates coupled with a job loss produce a tsunami that might not occur with a temporary job loss alone. The current Fed has set interest rates about as low as when Greenspan was promoting ARMs. There is no reason to believe that today’s ARMs will behave any differently than the past.
Given that we are at the bottom of the interest cycle and there is less than a point difference between fixed and variable rate home loans, only a fool would take an ARM. Logic would say that banks don’t want to lend to fools, so they should stop offering ARMs. Correspondingly, Fannie and Freddie should stop accepting ARMs from banks.
Fannie Mae was started in 1938 to put an end to balloon mortgages that had to be rolled over. The 30 year fixed rate mortgage, unique mostly to the United States, was born with Fannie. With the GSE back under the government fold, their lending practices should return to their roots. With all Treasury Secretary Paulson’s talk of moral hazard, why is he doing nothing to remove the moral hazard of ARMs?
Gamblers: Some Fannie preferreds can be bought for $1 and Freddie preferreds for 25 cents. It appears that the GSEs are maintaining their fees and Paulson is calling for expanding their portfolios with qualifying (read: higher quality) new mortgages. Looks like Paulson is managing the GSEs for profit after all. I think this will eventually benefit the preferreds, since they can’t be diluted. Don’t forget the GSEs are a gamble, not an investment. (Dividends have been suspended, and are non-cumulative for all Fannie and Freddie preferreds.)
Disclosure: Author is long FNM and FRE.
