Why ARM Rates Are So Close to 30-Year Rates Apparently, in 2002, it was “Hot In Herre” – or at least it was according to Nelly.

    I, however, had no idea because I had never heard the song, and I probably wouldn’t have trusted Nelly’s assessment in any case, given his inability to spell.

    I bring that up though because yesterday’s rates hit 2002 levels, taking us back to the days when really confusing music was a thing… oh wait… it still is (OK… back to when Nelly was a thing).

    Fortunately, rates came back down today, but they still remain near 20-year highs.

    So, we have clients and agents alike asking for Adjustable-Rate Mortgages (ARMs) for payment relief, and then asking why ARMs aren’t offering more payment relief (because ARM rates are so close to 30-year rates).

    5-Year and 7-Year ARMs (for which rates are fixed for 5 and 7 years, respectively, before rolling over to 6-month adjustable-rate loans) do offer lower rates than 30-year fixed options, but not that much lower. And I explain why below.

    INVERTED YIELD CURVE: Short-Term Rates Are Higher Than Long-Term Rates

    Traditionally, ARMs have/had much lower rates because the loans had less interest rate risk for lenders – meaning that if rates rose after the loan was issued, the lender would not be stuck with a below-market rate for 30 years. Also, there is just more risk in general when an entity loans money to someone for a longer period, so that risk comes with a higher cost.

    With a traditional “yield curve” longer maturities or longer fixed-rate terms come with higher rates, but that is not the case right now, as we have an “inverted yield curve.”

    The best example of this is a comparison of the 2 Year Treasury Yield to the 10 Year Treasury Yield. While typing this blog, the 2 Year Yield was about 4.47%, and the 10 Year Yield was about 4.02%, making the shorter-term yield almost 1/2% HIGHER than the longer-term yield.

    The yield curve inverts for a variety of reasons and Investopedia gives an in-depth explanation here.

    The brief explanation includes the fact that the Fed has been pushing up short-term rates, as those are the only rates the Fed has direct control over.

    And, more significantly, the yield curve often inverts prior to recessions, as investors pour out of stocks (to avoid price drops) and into longer-term bonds as a safe haven until recession concerns recede.

    This extra demand for longer-term bonds (like the 10 Year) pushes up bond prices which pushes yields down.

    And – according to this Inverted Yield Curve Chart from FRED, we have had a severely inverted yield curve since early July.

    Interestingly, prior to this year, the last time we saw an inverted 2 Year/10 Year yield curve was…wait for it… 2007. But don’t worry, everything was fine after 2007. 😊

    30-year mortgages are also more heavily traded, meaning there is a bigger market for them, so that is another reason why the spread between ARMs and 30-year mortgages is not larger.

    FINAL NOTE: There are other options for payment relief right now other than ARMs, and I will touch on those in Monday’s blog.

    Jay Voorhees
    Founder | JVM Lending
    (855) 855-4491 | DRE# 1197176, NMLS# 310167

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