## Friday, September 26, 2014

### Monthly payments on 30-year FRM versus 5-1 ARMs.

Question:   How have the 30-year Fixed Rate Mortgage Rate and the 5-1 Adjustable Rate Mortgage Rate Varied Over Time?  How are these rates currently in comparison to their past values?

Using the times series on 30-year FRM and 5-1 Adjustable Rate Mortgages calculate a time series of the mortgage payment on a \$200,000 loan.    What has been the typical payment differential?   What is the current payment differential?

Data:   The monthly data used in this exercise was obtained from
Freddie Mac.

The data covered the period January 2005 to August 2014.  (January 2005 was the first date where the 5-1 ARM data was available.)

Analysis:   Statistics on the 30-year FRM rate and the 5-1 ARM rate over the 2005 to 2014 period are presented below.

 Statistics on 30-year FRM and 5-year ARM rates – January 2005 to August 2014 30-year FRM 5-year ARM Diff. Average 5.10 4.43 0.67 Median 4.98 4.36 0.62 Standard Deviation 1.01 1.31 0.40 Minimum 3.35 2.61 -0.36 Maximum 6.76 6.36 1.49 Q1 4.26 3.04 0.35 Q3 6.13 5.80 1.04 Range 3.41 3.75 1.85 Interquartile Range 1.87 2.76 0.69 Aug-14 4.12 2.97 1.15

Observations on rates and rate differentials:

Both the 30-year FRM and the 5-1 ARM rates remain low.

The 30-year FRM is currently 4.12 below the 25th percentile for the 30-year FRM over the period.

The 5-1 ARM is 2.97 also below the 25th percentile of the 5-1 ARM.

The ARM rate is relatively low compared to the FRM rate.

The FRM-ARM differential in August 2014 stands at 1.15, which is above the 75th percentile for this differential.

A footnote:  It is worth noting that at the worse part of the financial crisis between December 2008 and April 2009 the 30-year FRM was lower than the 5-1 ARM.   This was clearly a perverse period.   Financial institutions were collapsing.   Banks were not lending.   Plus there were expectations of lower rates and a possible depression.

Payment Calculations:

In order to determine how rate differentials impact mortgage payments we must insert the observed rates, the period (360 months) and the loan amount (\$200,000) into the PMT function.

I do this and then look at statistics describing the monthly payment calculations:

 Information on monthly mortgage payments for 30-year FRM and 5-1 ARM January 2005 to August 2014 30-year FRM 5-1 ARM Diff. % Diff. Average \$1,091 \$1,012 \$78 7.55% Median \$1,072 \$1,000 \$74 6.74% Standard Deviation \$124 \$155 \$44 4.65% Minimum \$881 \$802 (\$45) -4.07% Maximum \$1,299 \$1,246 \$169 16.72% Q1 \$986 \$850 \$46 3.63% Q3 \$1,217 \$1,174 \$119 12.04% Range \$417 \$444 \$214 20.79% Interquartile Range \$231 \$324 \$73 8.40% Aug-14 \$970 \$842 \$128 13.17%

Example pertains to a \$200,000 loan.

Observations on monthly mortgage payment trends:

The median monthly payment difference over the entire time period in this example is \$74.

The payment difference in August 2014 is \$128.

Concluding thoughts:  Payment considerations will encourage many households to choose an ARM over the FRM.   But payment considerations are only one part of the puzzle.  ARMS are complex and risky.   Households considering an ARM need to look at this primer.