Monthly payments for homeowners with adjustable-rate mortgages continue to fall at one of the fastest rates ever, a development expected to save millions of California homeowners hundreds--and in many cases thousands--of dollars in payments this year.
That trend was underscored Monday with the announcement that the 11th District cost of funds index--the measure commonly used to set ARM payments in California, dropped for the 11th consecutive month in August to 6.845%, the lowest level in the index's 10-year existence.
Lenders expect the rate to continue falling into next year, possibly by as much as 1 percentage point, as the Federal Reserve Board moves to push interest rates down even more.
Lenders typically calculate the interest rate on ARMs at somewhere between 2 and 2.5 percentage points above the index. (Often new ARMs carry even lower "teaser" rates for a short period.) The rate is reset at certain intervals, with six months being a common period.
For a homeowner, the drop in the index means substantial savings on mortgage payments. A couple with $200,000 left on a typical ARM, for example, would pay about $2,500 a year less based on the current rate than the year-ago level. Some borrowers, however, may not have realized significant lower payments yet, depending on how frequently the lender resets the payment amounts as called for in the loan agreement.
The index, which measures what savings institutions in California, Arizona and Nevada pay for money, has been compiled by the Federal Home Loan Bank of San Francisco since July, 1981. It typically has been a slow-moving rate, except in the early 1980s when it rose and fell rapidly because interest rates were so volatile.
Since February, the index has fallen by more than 1 percentage point and it has been setting record lows since June. Other home loan indexes, such as those tied to one-year Treasury securities and six-month certificates of deposit, have plunged as well. Those indexes are used more by commercial banks.
The drop in the index stems mostly from the overall decline in interest rates this year. But other factors are important as well, such as the disappearance of several large, troubled thrifts offering customers high rates for deposits.
Jerry Hartzog, chief financial officer of the Federal Home Loan Bank Board, estimated in a recent interview that the annual savings nationwide for homeowners with loans ties to the index will be more than $2 billion.
Consumer groups, however, note that while people are saving money on lower mortgage payments, they also are seeing a drop in the interest rates banks and thrifts are paying on savings.
Ironically, ARMs have been unpopular in recent months--despite the drop in rates--because new home buyers and those refinancing existing loans are opting instead for low, fixed-rate loans to protect themselves against a future rise in rates.
"Any customer walking in the door is asking for a fixed-rate first," said Mark Ulmer, senior vice president of residential lending at California Federal Bank, in a recent interview.
In addition, mortgages rates tied to the cost-of-funds index are somewhat sticky, lagging behind overall drops in interest rates by several months. That makes them less attractive when rates are falling.
Major thrifts in the state hold about $150 billion in ARMs now, according to federal and trade group data. They began emphasizing making adjustable-rate loans in the early 1980s to protect themselves against fluctuations in the interest rates, although they do make a limited number of fixed-rate loans.
Mortgage originations for most major California thrifts, which typically depend heavily on making adjustable-rate loans for business, has fallen sharply this year, in some cases 20% to 40%.
Cost of Funds Falling
The 11th District Cost of Funds Index, the most common index lenders in California peg adjustable rate mortgages to, is compiled each month by the Federal Home Loan Bank of San Francisco. The rate in July fell below 7% for the first time ever, and is now at its lowest level since it was first compiled in 1981. The index reflects the cost of deposits and other funds for savings institutions in California, Arizona and Nevada.
Source: Federal Home Loan Bank of San Francisco
1986 1987 1988 1989 1990 1991 Jan. 8.770% 7.396% 7.615% 8.125% 8.359% 7.858% Feb. 8.964 7.448 7.647 8.346 8.403 7.848 March 8.744 7.314 7.509 8.423 8.258 7.654 April 8.587 7.245 7.519 8.648 8.211 7.501 May 8.441 7.223 7.497 8.797 8.171 7.329 June 8.374 7.274 7.618 8.923 8.086 7.155 July 8.196 7.275 7.593 8.844 8.109 6.998 Aug. 8.018 7.277 7.659 8.763 8.075 6.845 Sept. 7.901 7.394 7.847 8.807 8.091 Oct. 7.717 7.444 7.828 8.643 8.050 Nov. 7.602 7.562 7.914 8.595 8.044 Dec. 7.509 7.645 8.022 8.476 7.963
Source: Federal Home Loan Bank of San Francisco