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Home Buyers Turning to ARM Loans

With Interest Rates Up, Adjustable Mortgages Gaining in Popularity


The Federal Reserve Board's continued push to tighten credit has driven up mortgage rates to the point where many home buyers must choose creative financing options.

Californians particularly are embracing more innovative loan products in an effort to escape higher interest rates--at least for the short term--and to cope with record-high home prices.

This trend is expected to escalate in the wake of the Fed's move Tuesday to raise its benchmark short-term rate by one-half of a percentage point.

Home buyers here, faced with tight inventories and declining affordability in addition to rising interest rates, are choosing mortgages with adjustable interest rates twice as often as buyers elsewhere, economists say.

"There's been a real shift in consumer sentiment toward creative management of mortgages," said Keith Gumbinger, vice president of HSH Associates, a Butler, N.J.-based market research firm.

Adjustable-rate loans comprised about 59% of all conventional home loans made in California in the first quarter of this year, almost double the number of adjustable loans issued in the same period last year, said Brian Carey, an economist at the Mortgage Bankers Assn. of America.

National figures come in at about half this rate, with adjustable-rate loans making up about 31% of all conventional home loans in the first quarter, up from 12% in the first quarter of 1999, Carey said.

Buyers are increasingly asking for loans that carry a fixed rate for three, five or seven years and then switch to an adjustable rate after this time period, lenders say. These requests escalated when interest rates started trending upward last fall.

"We do see Californians being open to more flexible and newer types of financing," said Doug Perry, first vice president of the consumer markets division at Countrywide Credit Industries Inc., one of the nation's largest lenders. "Some of our newer products that allow borrowers to get into a home with no down payment are popular here."

Rates on adjustable mortgages are usually lower than fixed-rate loans, at least in the beginning of the loan period before the rate adjusts to meet market conditions.

For example, Freddie Mac set the first-year rate on its adjustable mortgage at 6.96% Tuesday, up about a percentage point from a year earlier. The average 30-year mortgage rate as measured by Freddie Mac rose to a five-year high of 8.52% last week.

Industry watchers say the Fed's latest move to increase interest rates--the sixth such increase since last June--was initiated in part to try to address the rise in inflation in housing costs.

"Rising interest rates coupled with rising prices will theoretically keep some buyers from showing up to bid," Gumbinger said. "That little bit of cooling off should allow inventory levels to build back up for a bit and for affordability rates to improve."

Historically, an increase in rates by the Fed has slowed the housing market, as it did in 1994 and 1995. But repeated attempts by the Fed to slow the market in the last year have been unsuccessful, and housing prices in California have hit record highs.

In anticipation of Tuesday's increase in interest rates, many Southern California home buyers locked in interest rates on their home loans in recent weeks while they were shopping for a home.

"We definitely sensed a lot of urgency and furiousness on the part of buyers to get into something before rates went up," said James Joseph, co-owner of Century 21 Grisham-Joseph in Whittier and seven other real estate offices in Los Angeles, Riverside and Orange counties.

The Fed's moves with its short-term rate don't directly affect long-term rates, such as for 30-year mortgages. But mortgages are tied to bond rates, which depend on investors' perceptions of inflation, economic strength and the Fed's rate intentions.

Many analysts believe that bond rates, and thus mortgage rates, have already risen in anticipation of the Fed's latest increase. Still, without a slower economy, long-term rates in general may have a hard time coming down soon.

But even though home sales in Los Angeles and Orange counties dropped off somewhat in April, "The good news here is that in spite of numerous rate hikes in the last year and a half, our demand is extremely strong," Joseph said.

More Coverage

* The Fed raises a key interest rate a half point to stave off inflation. A1

* For the first time in almost a year, consumer prices hold steady. C4

* How the Fed's move affects other interest rates. Chart, C4


The Fed Moves Again

The Federal Reserve on Tuesday raised its target for the federal funds rate, a key short-term rate in the U.S. banking system, to 6.5% from 6%. The trend in the fed funds rate since 1989:


Federal funds rate since 1989

Tuesday: 6.5%


Source:; Times research

The Mortgage Game

Adjustable-rate mortgages, which offer lower rates, are gaining popularity as rates rise. Monthly loan rate averages and latest from Freddie Mac:


Researched by NONA YAYES / Los Angeles Times

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