Up in ARMs

By Stephen Koepp

The perils of adjustable rates

In the past year, adjustable-rate mortgages have become the most popular way for Americans to buy homes. Though they represented only 13% of the $516 billion in total mortgages outstanding at the end of last year, ARMS now make up more than 60% of new home mortgages. Their attraction for home buyers is that they offer initial rates at about 2% lower than conventional fixed-rate mortgages, currently pushing 15%. But ARMS also present a gamble that consumers, in their anxiety to make an affordable deal, do not always appreciate. Reason: ARMS are tied to the general interest-rate level. Although monthly payments on ARMS can decline when interest rates go down, they are rising and are expected to go higher. Both lenders and Government officials worry out loud about the danger that the strain on families of keeping up with ever higher payments may result in a wave of defaults. One of the critics, House Majority Leader James Wright of Texas, blasts the ARM as "an abomination" that should be completely outlawed.

ARMS began to attract attention when interest rates started rising in the late 1970s. A year ago, an increasing number of home buyers viewed the ARM as the niftiest invention since aluminum siding. In November 1982, Houstonites Sheila and Bert Christensen would have been unable to afford their four-bedroom house at the daunting 15% going rate for a conventional mortgage. But with an ARM, the computer repairman and his wife paid an initial rate of just 11 7/8% on their $85,000 home. Now they wish they had never heard of ARMS. Last January their lender boosted the rate to 12 1/2%, raising the monthly payment from $750 to $825. The sudden increase, which amounted to an extra $900 a year, forced the strapped couple, who have four children, to visit a credit counselor and to cut back on expenses like hot lunches at work. The Christensens are bracing for another leap in their payments because interest rates are continuing to climb.

Lenders defend ARMS as one of the few effective ways to make homes affordable. Says Dennis Jacobe, senior vice president of the U.S. League of Savings Institutions: "The housing industry would be dead right now if it weren't for ARMS." Savings institutions also say they need ARMS as a hedge against interest-rate surges like the one in 1981-82, when many lenders were caught with fixed-rate loans that paid them as little as 41/2%. At the same time, the thrifts were forced to pay 10% or more in interest to depositors. Says Edwin Gray, chairman of the Federal Home Loan Bank Board: "Lenders must tie the fluctuating cost of money to lending to rates, or there will likely be no lenders left to make loans, by and by."

Gray and others, though, are concerned that some savings institutions have imprudently sold the loans to people who can ill afford them. Mortgage companies in such booming states as Florida and Texas have touted very low, so-called teaser rates that jolt upward in succeeding years of the mortgage. One Houston lender, Alpha Mortgage, offered a one-month introductory rate of 4 7/8% last year. The offer was never repeated. Says Alpha President Ron Redd: "If you're not careful, borrowers will just go out and spend the difference on something else and then be in trouble when time comes for the payments to increase." Indeed, the Milwaukee-based Mortgage Guaranty Insurance Corp. has found that delinquency and defaults are 35% more common in rising-payment loans than in fixed-payment ones.

The potential problems with ARMS have led many lenders to impose voluntary limits, or caps. San Francisco's First Nationwide Savings offers an ARM with an adjustment limit of 3/8% every six months and a maximum increase of 3 1/2% over the life of the loan. If such moves fail to make ARMS safer, Congress may have the last word. Next month the Housing Subcommittee of the House Banking Committee will hold hearings on the problems of adjustable rates. Curbs on the loans are possible, but there is unlikely to be a farewell to ARMS. --By Stephen Koepp. Reported by Gisela Bolte/ Washington

With reporting by Gisela Bolte