Economist's Commentary: March 3, 2008
Fed Chairman's Testimony Cautious on the Economy
Expected Rate Cut Would Provide Relief for ARM Homeowners
By George Ratiu, Research Economist
Federal Reserve Chairman Ben Bernanke spent two days last week in Congress delivering his semiannual monetary report. Bernanke's comments focused on the Fed's intent to continue monitoring economic conditions in an effort to avoid a recession. Based on his testimony, the economic consensus is that the Fed will provide a 50-basis point cut in the target fed funds rate, at the FOMC's March 18 meeting.
This move would likely lower short-term rates, providing relief to homeowners who are concerned about their adjustable rate mortgages (ARMs) resetting this year. Based on third quarter of 2007 data from Mortgage Bankers Association, the number of ARMs was 9.5 million, representing 20.9 percent of the mortgage market. The majority of those ARMs was made up of conventional prime mortgages (14%), followed by subprime (6.5%) and FHA loans (0.4%). The percentage of ARMs has remained constant for the past three years, at an average of 21 percent of the total number of mortgages.
However, due to a combination of factors, including rate resets and tightening lending standards, foreclosures on ARMs have accelerated during the past year. The sharp increase in ARM foreclosures has been driven primarily by subprime mortgages. Foreclosure inventories for subprime ARMs in the third quarter of 2007 moved from 8.0 percent in the second quarter to 10.4 percent of all subprime loans. Meanwhile, for prime ARMs, the number of foreclosures increased from 1.3 percent in the second quarter to 2.0 percent of all prime loans serviced.
The main concern with ARMs is the volume of rate resets for 2008, particularly since a number of the resets are affecting subprime ARMs originated in 2006. The recent drop in short-term interest rates, coupled with the Fed's willingness to provide additional cuts to its target rate, will provide relief to a large number of ARMs. The 1-year adjustable rate mortgage was 5.1 percent in the latest week, a tad higher from recent weeks but well below the 5.7 percent recorded prior to the Fed rate cuts from August of last year. NAR projects that 1-year ARM rate could fall to 4.7 percent by summer, thereby further relieving many homeowners who are facing resetting rates. The housing market still faces challenges, but falling adjustable-rate mortgages are good news for homeowners looking to refinance.
This is one in a series of commentaries by the Research staff of the National Association of REALTORS®.
