April 25 (Bloomberg) -- Mortgage refinancing in the U.S. is increasing as record numbers of homeowners dump their adjustable-rate mortgages for the security of a fixed loan.

The amount of refinanced home loans will reach $321 billion by the end of June, the most in a year, according to estimates from Washington-based Fannie Mae, the largest buyer of mortgages. Nine out of 10 of those borrowers will choose a fixed rate, Fannie Mae said.

Property owners are abandoning adjustable-rate mortgages, or ARMs, to ward off the prospect of higher payments. About 6 million U.S. homeowners, or 59 percent of the ARM market, have Libor-indexed loans, according to data compiled by Santa Ana, California-based First American CoreLogic Inc. The 12-month U.K. benchmark Libor rate rose more than two-thirds of a percentage point in the past month, according to Bankrate Inc. in North Palm Beach, Florida.

``Any ability people might have had to convince themselves that adjustable-rate mortgages don't have risk has completely evaporated,'' said Edward Glaeser, a professor of economics at Harvard University in Cambridge, Massachusetts, and editor of Quarterly Journal of Economics.

Almost all U.S. subprime loans and 41 percent of prime adjustable loans are linked to Libor, or the London interbank offered rate, First American CoreLogic said. Many Libor-indexed mortgages don't have the 2 percent cap on adjustments that are typical for Treasury-indexed loans, meaning homeowners could see their monthly payments double.

Sleepless Nights

``Like a lot of people I've been awake some nights worrying about what the Libor is going to do,'' said Marc Sherman, 51, of Manhattan Beach, California, who has a $440,000 adjustable loan linked to the U.K. benchmark rate that will reset next March. ``I may be switching to a fixed-rate loan.''

Homeowners are recoiling from adjustable loans after a surge in defaults led to last year's collapse in the U.S. subprime market, Glaeser said. Two-thirds of foreclosures were adjustable-rate mortgages in the fourth quarter, according to data compiled by the Mortgage Bankers Association in Washington.

The switch to fixed rates may further constrain the housing market as owners stay in their homes, said Keith Gumbinger, vice president of HSH Associates, a mortgage research firm in Pompton Plains, New Jersey.

``If you're stepping up to a higher interest rate and, on top of that, paying loan fees, it means you are making a commitment to stay put long enough to make those costs worth it,'' Gumbinger said.

All-Time Low

About $460 billion of adjustable-rate loans are scheduled to reset in the U.S. this year, according to analysts at New York-based Citigroup Inc. ARMs probably will account for 8 percent of new mortgages in 2008, a record low, said McLean, Virginia-based Freddie Mac, the second-largest U.S. mortgage buyer.

``People are afraid their mortgages are going to blow up in their faces,'' said William Fleckenstein, president of Fleckenstein Capital Inc. in Seattle and co-author of ``Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.''

The 3.1 million homeowners with prime adjustable loans linked to the 1-year Treasury note have less to worry about. The rate probably will drop to a four-year low of 1.9 percent this year, half of 2007's 4.5 percent, Washington-based Mortgage Bankers Association said in an April 10 forecast.

Greenspan's Role

The popularity of adjustable-rate mortgages climbed in 2004 when the portion of U.S. homebuyers opting for that type of loan almost doubled from the prior year. The ARM market share increased to 34 percent, the highest since 1994, from 19 percent in 2003, according Freddie Mac.

The increase may have been influenced by Alan Greenspan, then chairman of the Federal Reserve, Fleckenstein said. In a February 2004 speech to the Credit Union National Association in Washington three months before President George W. Bush nominated him for a fifth term to head the central bank, Greenspan appeared to endorse ARMs, Fleckenstein said.

``Homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages'' in the prior 10 years, Greenspan said. ``The traditional fixed-rate mortgage may be an expensive method of financing a home.''

A week later, Greenspan said he hadn't meant to disparage traditional mortgages. He said he had always preferred the security of fixed rates when getting his own home loans.

Rate Spreads

``I think the average person used Greenspan's support of adjustable mortgages as a rationalization for risky behavior,'' said Fleckenstein. ``A lot of people have gotten burned as a result.''

Homeowners with Libor-indexed loans who are refinancing are finding that the cost of fixed loans isn't much higher than adjustables, said Patrick Newport, an economist at Lexington, Massachusetts-based research firm Global Insight Inc.

The spread, or difference between the average U.S. fixed rate and the average adjustable rate for a 30-year mortgage, was 0.61 percent in the first quarter, the closest since the fourth quarter of 2000, data compiled by Freddie Mac show.

Rates for adjustable loans have fallen by only 0.5 of a percentage point since September, when the Federal Reserve began a series of seven rate cuts that shaved 3 percentage points off borrowing costs. Fixed rates for the three months ended in June probably will average 5.9 percent, compared with an average 5.18 percent for adjustable-rate loans, Fannie Mae said.

Credit Market Losses

Banks are reluctant to charge cheaper rates for adjustable loans after announcing record asset writedowns during the past year, Newport said. Banks and securities firms, including Washington Mutual Inc., Bank of America Corp. and Deutsche Bank AG, have reported almost $300 billion in writedowns and asset losses since last year, according to data compiled by Bloomberg.

``People would rather have the security of knowing what their monthly payment will be for the next 30 years, even if they won't be in the house for that long and don't actually need that much security,'' Newport said.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.

Last Updated: April 25, 2008 09:00 EDT