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TheStreet Open House

Outlook for ARMs Is Good Going Into 2014

NEW YORK (BankingMyWay) -- Adjustable rate mortgages were on the rise last week, with five-year ARMs rising to 3.25% from 3.05%, according to the BankingMyWay.com Weekly Mortgage Rate Tracker.

Normally, that might rankle homeowners who've opted for adjustable-rate mortgages. Such mortgages "open" with lower interest rates, then rise after the ARM's term expiration period. Most ARMS are packaged by mortgage lenders in one-, three-, and five-year loans.

After those loan periods expire, the mortgage interest rate and monthly payments adjust. How much the interest goes up is calculated by adding the agreed upon margin to an index such as the London Interbank Offered Rate. The size of the margin typically depends on the creditworthiness of the borrower.

Historically, those adjustable rates can ratchet upward significantly for homeowners, adding hundreds of dollars to a monthly mortgage payment.

But with the Federal Reserve's continued policy of lower interest rates (to promote "easier" lending by banks) keeping mortgage rates down, the outlook for ARM rates is a good one for homeowners heading into 2014.

According to Lender Processing Services, most (63%) outstanding hybrid ARMs have already reset this year, so mortgage holders can breathe a sigh of relief knowing their mortgage rates will remain relatively low, at least for another 12 months.

Of the remaining loans that have not reset, LPS says 75% of them originated in post-recession years, when most credit scores were higher and banks and lenders restricted their mortgage loans to low-risk homebuyers.

Thus those borrowers aren't likely to see higher ARM rates once they reset, LPS says.

"Only 36% of outstanding hybrid ARMs are in a pre-reset status, and the vast majority of those are coming from newer vintages where loan quality has been pristine," says Herb Blecher, a senior vice president at LPS. "That being the case, LPS looked closely at the remaining segment of pre-reset loans originated during the bubble years where underwriting criteria was not nearly as strict as post-crisis criteria -- since it is these borrowers who could arguably be most negatively impacted by upward resets in their monthly mortgage payments -- and sees little cause for concern."

Blecher says that some ARM mortgage holders may actually see their payments go down, given the current interest rate environment.

"With interest rate indices near historically low levels, we found that they would need to rise on the order of 300 basis points for most of these pre-crisis hybrid rates to increase," he says. "Most of these borrowers are more likely to be looking forward to a reduction in payments, rather than an increase."

One caveat: Mortgage lenders typically built in contractual "rate floors" that limit any significant decreases in ARM-related mortgage payments, Blecher says.

With interest rates for the majority of adjustable-rate mortgages unlikely to rise anytime soon, that gives ARM borrowers some breathing room -- and some time -- to plan accordingly if interest rates shoot upward late next year or in 2015.

Call it luck or call it a smart bet, but those ARM borrowers who were warned their mortgage payments would rise once the economy starting moving are once again having the last laugh -- this year, at least.

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