When shopping for a mortgage, prospective homebuyers and homeowners are often met with two numbers: the fixed mortgage rate and the adjustable-rate mortgage (ARM) rate. You might be surprised that these rates can differ significantly – sometimes by as much as half a percentage point or more. This rate discrepancy is known as the 'spread' between ARM and fixed mortgages, and it has been widening over the past few months.
In this blog post, we’ll take a closer look at why this spread is getting larger. We'll discuss current market conditions which have caused it to widen, what causes of wide spreads investors need to consider before committing to an ARM loan, and how this trend could impact housing prices throughout 2021.
Introducing the Mortgage Rate Spread
When shopping for a mortgage, prospective homebuyers and homeowners are often met with two numbers: the fixed mortgage rate and the adjustable-rate mortgage (ARM) rate. You might be surprised that these rates can differ significantly – sometimes by as much as half a percentage point or more. This rate discrepancy is known as the 'spread' between ARM and fixed mortgages, and it has been widening over the past few months.
The spread between ARM and fixed mortgages provides insight into current market conditions related to interest rates. When the spread is wide, lenders expect greater changes in interest rates, which means they are less likely to offer lower rates on ARMs because they have to account for higher potential future rates.
The Role of Interest Rates
One of the biggest drivers behind the widening spread between ARM and fixed mortgages has been changes in interest rates. The Federal Reserve recently increased its benchmark rate by 0.25%, resulting in an overall increase of 2% since December 2015. Lenders offer lower fixed mortgage rates to attract borrowers as interest rates increase. This means that ARMs become more expensive in comparison, causing the spread to widen further.
Inflation Expectations
Another factor influencing the spread is inflation expectations. As interest rates increase, lenders tend to expect higher inflation levels. This means lenders hesitate to offer lower fixed mortgage rates because they believe these mortgages will be less profitable due to expected price increases.
Borrowers and homeowners need to understand what is causing the widening spread between ARM and fixed mortgages so that they can make informed decisions regarding refinancing or taking out a new loan. Understanding current market conditions allows you to maximize your savings and take advantage of any opportunities available.
Fewer buyers for mortgage bonds
The spread between ARM and fixed mortgages can also be affected by the availability of mortgage bonds, which are financial instruments used to securitize mortgages. With fewer buyers for these mortgage bonds, lenders offer higher rates on ARMs to remain competitive.
This causes the spread between ARM and fixed mortgages to widen as borrowers look for better deals elsewhere. This lack of demand for mortgage bonds could occur due to several reasons, such as increased regulations, tightening credit conditions, or a decrease in investor confidence. Investors may also be wary of taking on additional risk if they feel that interest rates will increase further. Regardless of the cause, lower demand ultimately results in higher borrowing costs as lenders increase the spread between fixed and ARM rates.
The Future of the Mortgage Rate Spread - Expectations and Predictions from Experts
Experts expect the spread between ARM and fixed mortgages to remain wide shortly due to the current economic conditions. According to analysts, lenders will continue to offer relatively high rates on ARMs as they anticipate higher interest rates and inflation levels. In addition, they believe that fewer buyers for mortgage bonds will persist, which could cause spreads to widen further.
The Mortgage Bankers Association (MBA) expects the 30-year fixed mortgage originations rate to increase slightly over the next 12 months, while ARM originations are expected to decline in volume and percentage. The MBA also predicts that average ARM rates will remain at least a quarter point above those for fixed mortgages through 2021.
Despite the wide spread between fixed and ARM mortgages, experts note that such conditions are still relatively favorable for borrowers. The average 30-year fixed mortgage rate is still hovering near historic lows, making it attractive to those looking to purchase a home or refinance their existing mortgage.
A drag on the housing market
The current spread between ARM and fixed mortgages is dragging the housing market. With higher borrowing costs, potential buyers may no longer be able to purchase certain homes, causing sales of existing homes and new construction to suffer.
In addition, as lenders offer lower fixed mortgage rates, homeowners may struggle to refinance their existing mortgages at a lower rate due to the widening spread. This could create negative equity situations for homeowners if they cannot secure a loan with an acceptable interest rate.
Impact of a Steep Spread on Homebuyers
The widening spread between ARM and fixed mortgages also affects homebuyers more immediately. With ARM rates higher than fixed mortgage rates, homeowners may hesitate to take out an adjustable-rate loan. This could limit their borrowing power, as the amount they qualify for will be lower due to a higher interest rate. In addition, lenders are likely to require larger down payments on ARMs due to the increased risk of future rate increases.
The widening spread between ARM and fixed mortgages is creating a drag on the housing market that could have long-term economic implications if addressed later. Homeowners should consider all options before taking out a new loan or refinancing an existing one, as the current spread offers unique opportunities but presents certain risks.
Borrowers must understand these risks and make informed decisions regarding their mortgages. Taking the time to fully understand the market conditions can help ensure you get the best deal possible for your new or existing loan.
FAQs
Q: What other factors could be causing this discrepancy?
A: More specific causes can also affect the spread between ARM and fixed mortgage rates. For example, lenders sometimes charge higher interest on adjustable-rate mortgages to offset potential risks associated with the loan. This is because borrowers with adjustable-rate mortgages are more likely to refinance or switch lenders when their interest rates reset after the initial fixed payment period. Additionally, mortgage brokers may offer different rates depending on which type of loan they are offering, and this can also contribute to a wider spread between ARM and fixed mortgages.
Q: What should I consider when shopping for a mortgage?
A: When shopping for a mortgage, comparing fixed and adjustable-rate mortgages is important to determine which option best fits your needs. Consider how long you plan to stay in the home, the number of monthly payments you are comfortable making, and any potential risks associated with an ARM loan. Shopping around and comparing different lenders is also important to ensure you get the lowest interest rates possible. Making an informed decision is the key to getting the right loan at the best rate for your financial situation.
Q: Is the spread between ARM and fixed mortgages expected to stay wide?
A: This is challenging to predict as it depends on economic conditions. The Federal Reserve has indicated that they plan to keep rates low for the foreseeable future, which could further widen the spread between ARM and fixed mortgages. However, any changes in investor demand or other market factors could cause this spread to narrow. Borrowers must know about changing market conditions to adjust their mortgage strategy if necessary.
Conclusion
The spread between ARM and fixed mortgages has been increasing in recent months due to current market conditions and restrictions on refinancing. Prospective homebuyers and homeowners need to understand the factors driving this discrepancy to make an informed decision when buying a mortgage. Furthermore, monitoring economic developments can help borrowers adjust their strategy to get the best rates possible.
