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Few Adjustable Rate Mortgages Affected by Rising Rates

NEW YORK ( TheStreet) -- Rising interest rates may be hurting mortgage production volumes but concerns that they may spark a new wave of defaults among adjustable-rate mortgage borrowers are unfounded, according to a new report from Lender Processing Services.

The interest rate for adjustable-rate mortgages (ARM) is reset periodically in relation to an index. These loans start with a lower monthly mortgage payment than a fixed-rate loan, but rates can go up as interest rates rise.

Interest rates have been steady and low through most of the crisis, but with the uptick since May, there have been concerns that borrowers with adjustable-rate mortgages may be hit by an upward reset in mortgage payments.

But LPS says there isn't much cause for concern. For one, more than 60% of outstanding hybrid ARMs have already been reset from their initial rates.

Of the remaining that are yet to reset, 75% were originated post-crisis, when loan quality has generally been pristine. More than 60% of the ARMs originated after 2010 has been to borrowers with credit scores greater than 760, so the likelihood of default is low.

The remainder of the ARMs yet to reset were originated during bubble years when credit was loose. Arguably, these borrowers would be negatively impacted by an upward reset of monthly mortgage payments.

But with interest rate indices still low, the indices would need to rise 300 basis points for most of the pre-crisis hybrid rates to rise. In fact, "Most of these borrowers are more likely to be looking forward to a reduction in payments, rather than an increase," says Herb Blecher, senior vice president at LPS.

Rising rates have however definitely taken a toll on refinancing activity, the report shows. Overall origination volumes were down more than 9% from the last month and have declined 18% year-to-date.

-- Written by Shanthi Bharatwaj New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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