US mortgage bankers warn Fed on adjustable loans

By Mark Felsenthal and Alister Bull

WASHINGTON, May 21 (Reuters) - A surge in U.S. borrowers choosing adjustable mortgages may lead to more delinquencies as interest rates rise, a mortgage banking trade group cautioned the Federal Reserve in a private meeting this week.

Adjustable mortgages have more credit problems than fixed-rate loans, the Mortgage Bankers Association told the central bank in a paper presented on Tuesday and made available to Reuters on Friday.

"An increasing interest rate environment which generates an increased number of ARM loans can be expected to generate a decline in the average quality of the mortgage portfolio," the group said.

Economists expect the Fed to start tightening rates from 1 percent -- the lowest since 1958 -- at their meeting at the end of June, after U.S. inflation started to pick up amid strong growth and evidence of a tightening labor market.

The Fed recently said it can afford to raise rates at a "measured" pace, playing down fears it will jeopardize the recovery by inflicting too much pain on heavily borrowed households.

Many Americans, in fact, have fixed-rate mortgages, and so are insulated from monetary tightening. But the Fed's meeting with the MBA signals that the central bank is keen to know more about those opting to expose themselves to adjustable loans.

"It's a function of (Fed Chairman) Alan Greenspan -- because he is a real data hound," said Doug Duncan, chief economist for the Mortgage Bankers Association.

"He's going to ask questions that he thinks will elicit more information on the relationship between the Fed's policy decisions, the housing market, and how the overall economy operates," he said.

The share of borrowers opting for ARMs -- whose rates rise in step with benchmark interest rates after an initial period -- came close to a record high in early May, the mortgage bankers said.

ARMs accounted for 34.8 percent of mortgage applications in the week ended May 7, just below the record share of 35.5 percent in December 1994. In the first quarter of 2004, 30 percent of the $600 billion new mortgages were adjustable.

ARMs become more popular when rates rise because they require lower monthly payments than fixed-rate mortgages. But ARMs, as a share of all mortgages, have risen faster recently than when rates climbed at the end of 1993 and 1998, the mortgage bankers said.

This is because the sharp rise in house prices in the last several years has forced borrowers to rely more on ARMs to finance home purchases, the group said.

ARMs have also grown as a proportion of subprime mortgages with higher rates that are made to borrowers with blemished credit. Subprime loans make up a bigger share of all mortgages now that refinancing has slowed sharply with an upturn in interest rates.

 

 

 

 

 

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