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Adjustable-Rate Mortgages Regain Popularity as Prices, Rates Rise

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By Andrew Khouri

(MCT)—When Michael Shuken recently bought his family’s first home, a four-bedroom in Los Angeles’ Mar Vista area, his adjustable-rate mortgage helped them stay on the pricey Westside.

For now, his interest-only loan costs him about 35 percent less per month than a 30-year fixed mortgage, he said. But he’ll have a much bigger monthly bill in 10 years, when the loan terms require him to start paying off principal at potentially high rates.

“What is going to happen if I can’t restructure my loan and extend it? Are interest rates going to be 7 percent, 8 percent?” the 43-year-old commercial real estate broker said. “The home is big enough for me to grow into. The question is, will I be able to?”

Adjustable-rate mortgages, which all but vanished during the housing bust, are again gaining popularity. Home prices and interest rates rose last year, and adjustable mortgages can help keep the monthly payment affordable—at least temporarily. Such mortgages offer a lower initial rate, but that rate can rise over time with market changes.

With interest rates expected to rise this year, the proportion of ARMs could increase further.

“Generally, as rates increase, ARMs become more popular,” said Guy D. Cecala, publisher of Inside Mortgage Finance.

Last week, lenders offered, on average, a 3.05 percent interest rate for a 5/1-year ARM — which means a borrower receives that rate for five years, before the loan starts to adjust annually with the market. That’s compared with 4.53 percent for a 30-year fixed loan, according to mortgage giant Freddie Mac.

Mortgage brokers say borrowers who plan to move after a few years, or those with considerable, but irregular, income could be well-suited for an ARM.

“A big percentage of my clients are freelance employees in entertainment,” Ciolino said. “So they are going job to job, and they are concerned with having a higher mortgage payment.”

ARMs have been most popular in some higher-priced communities. That’s a contrast to last decade’s housing bubble, when lenders flooded working-class communities with extremely risky mortgages. One such product — known as the option ARM — allowed borrowers to pay even less than the interest owed, swelling the size of the loan as unpaid interest was added on to principal.

Many borrowers who took such loans bet home prices would continue to rise, allowing them to easily refinance or sell before the first adjustment. Many got burned when home prices plummeted, preventing any refinancing.

It’s unclear whether such thinking has changed, but the loans have. The crash stung lenders as well, making them skittish about offering the riskiest products.

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