Americans swinging back to fixed mortgages

Press, 15 October 1986, Page 43

Americans swinging back to fixed mortgages

From the “Economist,” London Fixed interest-rate mortgages are back in fashion in America. The proportion of new housing loans that bear, adjustable rates has dwindled from almost 70 per cent in late 1984 to 20 per cent to 25 per cent in recent months as American home buyers rush to lock into low fixed-interest loans. That proportion may fall further as more borrowers, expecting interest rates to rise, refinance their mortgages. This horrifies some in the mortgage business. They fear a repeat of 1980, when a steep rise in interest rates toppled hundreds of savings and loan associations (S and Ls). Adjustable-rate mortgages (ARMS), long standard in Europe and Canada, are a fairly new arrival in America. Federally chartered S and Ls were barred from making them until 1981. When interest rates soared in the three years to late 1981, the S and Ls, saddled with low fixed-rate mortgages, found themselves paying more for their (floating-rate) short-

term funds than they were earning from their (fixed-rate) long-term loans. As a result, almost a quarter of the 4000 S and Ls that existed in 1980 have since failed or gone into shotgun mergers. And up to a third of the survivors are on the verge of insolvency. During the last few years, S and Ls have tried to shield themselves against future interestrate movements by giving more adjustable-rate mortgages. These transfer the risk of interest-rate swings from lender to borrower. At first, home buyers were as eager as lenders to switch to ARMs — partly because initial interest rates are typically lower (currently by 150 basis points) than those available on fixed-rate loans; partly because promotional discounts lured customers. The share of ARMs jumped from practically nothing in 1981 to almost 70 per cent in 1984. Since then, the attraction of ARMs to home buyers has waned as interest rates have slid. The lower interest rates drop now, the more likely it is

that the next adjustment will be up. And Americans like the certainty and ease of financial planning that fixed-rate mortgages provide. So they are demanding them again. Competition between thrifts is so intense that S and Ls are again providing fixed-rate housing loans, despite the horrors of 1978-81. They seek solace in the thought that, initially at last, they are more profitable than ARMs because interest rates on fixed mortgages begin U/ 2 percentage points higher. Thrifts are seeking ways to protect themselves from another 1980. To make ARMs more attractive, they have introduced all sorts of tricks, such as limiting the size and frequency of interestrate adjustments. The typical American ARM is adjusted only once a year and by a maximum of two percentage points each time. The snag for the lender is that this makes the ARM less sensitive to the cost of money and so fails to protect the lender fully against interest-rate fluctuations. A second line of insur-

ance against interest-rate changes is the expansion of the secondary market for mortgages. In this “securitisation,” lenders package mortages together to sell them to an investment house or to such government-spon-sored agencies as Ginnie Mae (the Government National Mortgage Association) and Fannie Mae (the Federal National Mortgage Association). This relieves the original lender of the interest-rate risk. In 1980, SUS2O billion of mort-gage-backed securities were sold; by 1985, almost $l5O billion, roughly twothirds of new mortgages. The mortgage business is therefore much less vulnerable to a sharp increase in interest rates than it was a few years ago. But not everybody in the business is wiser. Some thrifts, with longer memories than the rest, are selling all their fixed interest-rate loans to institutional investors; but others, tempted by the fatter margins on fixedrate loans, are holding on to them. For them, prosperity today could mean insolvency tomorrow.