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Adjustable-rate loans making a comeback

Adjustable-rate mortgages, which all but vanished during the housing bust, are again gaining popularity.

Home prices and interest rates rose last year, and adjustable mortgages can help keep the monthly payment affordable – at least temporarily. Such mortgages offer a lower initial rate, but that rate can rise over time with market changes.

With interest rates expected to rise this year, the proportion of those ARMs could increase further.

“Generally, as rates increase, ARMs become more popular,” said Guy D. Cecala, publisher of Inside Mortgage Finance.

Lenders recently offered, on average, a 3.05 percent interest rate for a 5/1-year ARM. Borrower would get that rate for five years, and then the loan starts to adjust annually with the market. That’s compared with 4.53 percent for a 30-year fixed loan, according to mortgage giant Freddie Mac.

Mortgage brokers say borrowers who plan to move after a few years, or those with considerable, but irregular, income could be well-suited for an ARM.

“A big percentage of my clients are freelance employees in entertainment,” Ciolino said. “So they are going job to job, and they are concerned with having a higher mortgage payment.”

ARMs have been most popular in some higher-priced communities. That’s a contrast to last decade’s housing bubble, when lenders flooded working-class communities with extremely risky mortgages. One such product – known as the option ARM – allowed borrowers to pay even less than the interest owed, swelling the size of the loan as unpaid interest was added on to principal.

Many borrowers who took such loans bet home prices would continue to rise, allowing them to easily refinance or sell before the first adjustment. Many got burned when home prices plummeted, preventing any refinancing.

It’s unclear whether such thinking has changed, but the loans have. The crash stung lenders as well, making them skittish about offering the riskiest products.

Largely gone are option ARMs and loans with very low “teaser” rates that quickly exploded into payments that borrowers couldn’t afford. Lenders during the bubble years also qualified borrowers based on teaser rates, increasing the likelihood of default.

“The ARM products that remain in the marketplace today … are really venerable, long-dated products,” said Keith T. Gumbinger, vice president of financial publisher HSH.com.

New federal regulations that took effect in January should further curtail some of the riskier ARMs, including interest-only products and those with balloon payments.

Adjustable-rate loans may work for some buyers, such as a family in which one parent will return to work after staying home with the kids, said Gary Kalman, an executive vice president with the Center for Responsible Lending.

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