It May Be Time To Take Up Ar Ms

Just when you thought it was safe to jump back into the housing market, the Federal Reserve Board ratcheted up interest rates, and 30-year fixed mortgages rose from 7% to almost 9% in only three months. Don't panic. There are some tempting options in adjustable rate mortgages (ARMs), which come in more varieties than ever. And even at the higher rates, good deals are still to be had.

For the bulk of real estatebuyers who want a 30-year fixed mortgage, the next best thing may be the new 10/1 ARM, says Paul Havemann, vice-president of mortgage-tracking service HSH Associates. The 10/1's rate is set for 10 years at almost half a point less than a 30-year fixed, now 8.45%. In the 11th year, it converts to a one-year ARM that tracks prevailing rates annually.

LOW CEILING. The 10/1, currently at 7.87%, is just a fraction below the 15-year fixed rate of 8%, but you can pay it over a period of 30 years, so you get the lower rate without the higher payments. And since most people move every five to seven years, chances are that you'll already have sold your house before the loan converts. So far, only big banks that keep their loans are offering 10/1s, because the secondary market isn't buying them yet. But they're spreading. They're available at such national lenders as PNC Bank in Pittsburgh, Nationsbank Mortgage Corp. in Tampa, and GMAC Mortgage in Elkins Park, Pa.

At the other end of the spectrum are loans that adjust every month, which are just catching on in regions outside the Southwest. Such mortgages are tied to the 11th District's cost-of-funds index (COFI)--the rates that Southwestern banks pay their depositors. These COFI ARMs change much less frequently than Treasury bills. "Even in the early '80s, [COFIs] never went up two points in one year," says Margaret Scott, president of Mortgage Advisory Services in New York. "It's a great mortgage for this market." Typical COFI ARM starting rates are 63/4%, with ceilings of 10.45%. That's lower than many ARMs tied to Treasuries. Right now, you can get a 4.4% teaser rate for four months, says Scott. COFI ARMs can be paid over 15, 20, 30, or 40 years, but they carry some points.

Scott doesn't like one-year ARMs right now because, unless you happen to get a bargain-basement rate, after one year you're most likely to wind up paying almost 8%--when you could have a fixed rate for slightly more. Nevertheless, you can choose an ARM with a fixed rate that adjusts every one, three, or five years, or an ARM that converts to a one-year adjustable after one, three, five, or seven years. The 7/23 changes once and then stays fixed for 23 years but at a slightly higher rate and often a higher cap than that of a 7/1.

Which ARM you choose depends on how long you plan to keep the house. If it's only three years, a 5.5% one-year ARM makes more sense than a 30-year fixed. Even if rates rise the maximum two points a year on a $100,000 loan, you would pay out $25,152 at an average rate of 7.5% after three years, as opposed to $27,681 for an 8.5% 30-year fixed loan.

Despite higher rates, even some run-of-the-mill ARMs are good deals because the market is so competitive. Savings and loans, which don't resell mortgages, are offering "suicidal rates of 3%" for one-year ARMs, says Havemann. Lenders are also trying to lure customers with "bells and whistles" such as preapproved mortgages, accelerated processing, and loans with free insurance on your payment in the event that you lose your job, says David Lereah, chief economist at the Mortgage Bankers Assn.

WORST CASE. You may drool over a 3% one-year ARM, but make sure you can afford the payments if rates go up, Lereah warns. Examine the annual and lifetime caps to see what your worst-case liability would be. Usually adjustables can't rise more than 2 points a year and no more than 6 points over the life of the loan. But some five- and seven-year ARMs have 4% lifetime caps, and the 10/1 ARMs at Nationsbank can jump as much as 5 points in the 11th year.

Also, beware of loans that cap your monthly payments. Even if rates rise, your payments stay fixed, but the extra amount you would have paid on your principal and interest is added to the balance you owe. This is called negative amortization, and since it raises your principal, you can wind up paying a lot more over the life of the loan. But with some careful planning and comparison shopping, you won't have to give up on that dream house yet.

      Loan            Average rate*  PROS                   CONS
      1-MONTH ARM             3.61%  Tied to a more stable    Most likely to carry
                                     index than Treasuries    negative amortization
      ONE-YEAR ARM            5.44   Low teaser rates;        After a year, rate not
                                     easily converts to fixed much better than fixed
      7-YEAR FIXED, THEN      7.65   Average consumer sells   Can get hammered
      1-YEAR ARM                     before loan converts     after seven years
      7-YEAR FIXED, THEN      8.13   Rate changes once        Can jump six points
      23-YEAR FIXED                  after seven years        when it does adjust
      10-YEAR FIXED,          7.87   10-year rate half-point  Not all lenders
      THEN 1-YEAR ARM                below 30-year fixed      offer them
      15-YEAR FIXED           7.98   You pay off your         Larger monthly nut
                                     principal faster         than 30-year
      30-YEAR FIXED           8.45   You know exact pay-      Doesn't pay if you
                                     ments over the long term move within 10 years
      * As of 6/10/94         DATA: HSH ASSOCIATES, BUSINESS WEEK     ARM=Adjustable-rate mortgage
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