Freddie Mac has conducted its 30th annual adjustable rate mortgage (ARM) survey and the hybrids have it!

Intro period interest rates have increased year-over-year. However, ARMs use, in general is still at historic lows. At the time of the survey, the 30-year fixed rate mortgage (FRM) interest rate registered at 4.51%. The intro rate for a 5/1 hybrid ARM (the most popular ARM, according to Freddie Mac) was a scant 3.15%, reminiscent of the FRM rates of yesteryear.

Check out the following chart, which shows the historic development of ARMs use. Note that their use overall trends downward in a falling interest rate environment. But hybrid ARMs have continuously increased in popularity.

Chart courtesy of Freddie Mac


Frank Nothaft, Vice President and chief economist at Freddie Mac, was quoted as saying borrowers have preferred FRMs for the past several years since rates have been historically low. But he went on to say,

“As longer-term rates rise, ARMs with their lower initial interest rates will become more appealing to loan applicants. Hybrid ARMs are particularly attractive because they have an initial extended fixed-rate period of 3 to 10 years.”

What Mr. Nothaft has to say is absolutely right, and it’s terrifying.

We follow the ARM-to-loan ratio in the state of California very closely as it is an indicator of the housing market’s stability. ARMs use typically rises when the cost of homeownership rises out of reach of average end-users, either through an increase in interest rates, prices or both.

The ARMs ratio has remained under control in California despite the unusual dual increase of prices and interest rates and dismally low buyer purchasing power (BPP). But it won’t stay that way for long. If prices and/or interest rates do not decline quickly enough to make for reasonable BPP, ARMs are going to step in to fill demand.

The terrifying thing about all this is that the “popular” hybrid ARM is an insidious little beast capable of doing real damage to the real estate market. “Hybrid” is really a euphemism. It is more appropriate to call them “imposter loans.” That’s because they look like FRMs, for quite some time. But after five years, the loan resets to current market rates. Rest assured, interest rates are going to be much higher five years from now and borrowers who overreach today with a 5/1 hybrid ARM are going to be sorry.

A better solution is low-rate loan assumptions. But that’s a whole other story.