Are Low Interest Rates Killing FHA ARMs?

by Peter G. Miller
July 7th, 2010

I keep looking at the latest interest rates and I’m sure that someone is either joking or we’re all victims of a massive typo. According to Freddie Mac, interest levels for fixed-rate financing reached 4.58 percent with .7 points just before the Fourth of July. That’s down from 5.32 percent last year, a rate that itself was insanely low.

“Interest rates on fixed-rate mortgages and the 5-year hybrid ARM fell once again to all-time record lows this week in a period where the economy struggles to gain momentum and inflation remains very low,” says Frank Nothaft, Freddie Mac vice president and chief economist.

If you’re in the market for an FHA loan you have to love these rates. If you’re the FHA you also have to love these rates. Here’s why:


In May the HUD reported that 3,383 borrowers were approved for adjustable FHA mortgages. Amazingly, this number is up 827 percent (really, no joke) when only 365 borrowers got FHA ARMs.

Also in May, just 2.7 percent of all FHA forward loan approvals were for adjustable-rate products. The other 97.3 percent were for fixed-rate loans.

I’m trying to figure out why anyone would want an adjustable-rate mortgage in today’s world. Does someone believe that interest rates will trend lower during the next few years? Does that really seem likely? How much lower could they possibly go?

As I tell folks, with an ARM the risk of inflation is shifted from lenders to borrowers. If interest rates rise, so do monthly ARM costs. In the world of conventional mortgages, lenders try to induce borrowers to go for ARMs by easing the qualification standards so that more can be borrowed if only the borrower will opt for an adjustable loan product. With an FHA ARM, the attraction is a lower up-front rate, now 3.8 percent according to Freddie Mac.

Why The FHA Should Be Elated

I have no doubt that some of the happiest people in Washington are the government officials who monitor FHA loan trends. I picture them dancing on the Mall every time a borrower elects to get a vanilla fixed-rate loan.

Why should FHA officials be happy? Because the FHA is an insurance program and not actually a lender. The FHA does not want any loan to fail and the odds are that if a loan fails it will be adjustable. For example, in May the Mortgage Bankers Association reported that “on a seasonally adjusted basis, the delinquency rate stood at 6.17 percent for prime fixed loans, 13.52 percent for prime ARM loans, 25.69 percent for subprime fixed loans, 29.09 percent for subprime ARM loans, 13.15 percent for FHA loans, and 7.96 percent for VA loans.”

If people are financing and refinancing with FHA fixed-rate loans that’s just dandy with the government. It means borrowers are locking in historically-low rates, and that means less risk for the FHA program.

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