Adjustable-rate mortgages accounted for a smaller share of prime loans in 2007 as their interest-rate advantage over fixed-rate loans shrank and lenders offered smaller discounts on introductory rates.

Those are among the findings of Freddie Mac’s annual survey of prime adjustable-rate mortgage (ARM) loans, which found 3/1 and 5/1 hybrid ARMs were the most widely available ARM loan.

The survey, based on data collected in the third week of December, found little difference between the initial rate discount on hybrid ARM loans and the fully indexed rate after the introductory rate expires. While fully indexed interest rates fell to their lowest levels in three years in 2007, starting rates were close to or above rates of a year earlier.

“A year ago, the initial rate discount on the popular 3/1 and 5/1 hybrid products was about 1.8 percentage points,” said Freddie Mac Chief Economist Frank Nothaft in a statement. “In our latest survey, the rate discount had virtually disappeared on these products.”

ARM loans accounted for only 17 percent of loan applications in October, Freddie Mac said, citing an earlier survey — the lowest level since June 2003. The market share for ARM loans has fluctuated between 11 percent and 33 percent since Freddie Mac began collecting data in 1995, hitting its peak in 2004.

“Consumers respond to changes in the relative cost of different loan products,” Nothaft said. “As ARMs became more expensive relative to fixed-rate loans during the closing months of 2007, the ARM share of lending declined.”

One reason ARM loans became more expensive was their poor performance compared to fixed-rate loans.

At the end of September, the serious delinquency rate on prime ARM loans was 3.1 percent, compared with 0.8 percent for prime fixed-rate loans, Nothaft noted, citing figures from the Mortgage Bankers Association. That’s nearly triple the 1.1 percent serious delinquency rate for ARM loans in September 2006.

As a result, lenders have tightened underwriting standards, and investors who fund ARM loans are demanding higher returns.

The average initial rate on a jumbo 1-year ARM was about one-quarter of a percentage point higher than the rate on comparable loan within the $417,000 conforming loan limit, the largest gap in seven years, the survey showed. The increase reflects the higher funding costs for all jumbo loans in the wake of the capital market disruptions since August, Freddie Mac said.

Hybrid 5/1 ARMs, which the survey found have become the most popular ARM loans with consumers, were offered by 93 percent of lenders. The average initial interest rate on 5/1 hybrid ARMs was 6 percent, about 0.1 percentage point below the rate on a 30-year fixed-rate mortgage.

Treasury-indexed ARM characteristics, 2007

Source: Freddie Mac

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