A wide swath of borrowers today may be paying far too much on their home loans, simply because they are overly cautious.
"It's personality. Some people are just risk averse, but how much is your risk aversion worth?" asked Craig Strent, CEO of Maryland-based Apex Home Loans, an independent mortgage lender.
More than 93 percent of mortgage applications to both refinance and to purchase a home are for fixed-rate loans, according to the Mortgage Bankers Association. Adjustable-rate mortgages (ARMs), which may be fixed for up to 10 years before the interest rate changes, can offer rates at least a full percentage point lower, but they are less popular today than they've ever been.
That is because ARMs are associated with the high-risk lending that resulted in the worst housing crash in U.S. history. In 2005, close to 40 percent of new loans were ARMs.
"I think it's just fear and the nightmare, I mean, you remember the exploding subprime adjustable-rate mortgage," said Mark Zandi, chief economist at Moody's Analytics. "That was at top of mind just a few years ago, and so it's going to take a while before people really get over their fear and buy into the idea that an ARM might be a good deal for them."
Today's adjustable-rate loans are nothing like those of the past. They are largely underwritten to the full term of the loan and subject to new mortgage regulations from the Consumer Financial Protection Bureau and its "ability to repay" rule. Most ARMs now combine interest and principal payments, but some lenders do offer interest-only ARMs. These, however, are held on lenders' books and are most often used by high net worth customers, who are using mortgages for investment and cash management purposes, not to qualify for a more expensive house.
ARMs have also been less popular simply because the average rate on the 30-year fixed has been so low for so long. The spread between a 30-year fixed and a five- or seven-year ARM is usually more than twice what it is now. That has made the risk of an ARM less worth it, so far, but that is about to change.
"ARMs are more attractive when 30-year interest rates increase," said Matt Weaver, vice-president at Finance of America Mortgage, a Blackstone company. "Right now we're in a very funny time. Jumbo mortgage rates and 30-year fixed are the same."
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