WASHINGTON -- The Federal Housing Administration would be allowed to insure hybrid adjustable rate mortgages (ARMs) under a funding bill approved last week by the House VA-HUD Appropriations Subcommittee.

The FHA cannot now underwrite hybrid ARMs, loans which have an initial interest rate that remains fixed for the first three, five, seven or ten years and then switches to a one-year adjustable rate mortgage. In general terms, such loans are described as 3/1, 5/1. 7/1 and 10/1 ARMs.

With 30-year loan rates hovering around 7-7.25 percent, ARMs are not particularly popular at the moment. But with the difference between fixed and adjustable rates beginning to widen a bit, 5-1 ARMs are once again attracting some attention among home buyers who believe they'll be moving sometime before their 60th payment is due.

Fixed-period adjustables are not new; they've been available in the conventional loan sector since the early '90s. But they become more popular in periods of rising mortgage rates when the cost differential between standard 30-year fixed-rate loans and pure adjustables widens enough to make it worthwhile for borrowers to take a chance their payments could go up sometime in the future.

Hybrids aren't as dangerous as, say, a one-year adjustable in which your payments could rise -- or fall -- on an annual basis depending on market conditions at the time. They aren't as cheap, either. But they are somewhat more perilous to borrowers -- and, therefore, less expensive -- than fixed-rate loans in which you know exactly how much you'll pay in principal and interest, month-in and month-out, for the entire life of your loan.

Of the four varieties, the 5/1 seems to have risen above the rest. "It seems to fit best because it gives borrowers enough time to earn enough of a return for the risk they are taking on," says Keith Gumbinger of HSH Associates, a Butler, N.J., financial publisher.

On the other hand, the rate differential between 3/1s and one-year ARMs hasn't been great enough to attract more than passing interest on the part of bargain hunters.

"Unless you get a serious price break, you might as well go with an ARM," says Gumbinger. "Otherwise, it's just too short a period. Just about the time you finally settle in, you could be hit with a big increase in your house payment."

The seven and 10-year versions haven't been terribly popular of late, either, largely because the spread between them and fixed loans has been "so thin" that borrowers might as well pay full price and let the lender assume all the future risk.

In January, the difference between 5/1 hybrids and fixed-rate loans wasn't very large, either. In fact, the 16 basis point spread was the slimmest in the last two years. By contrast, in August 1999, the difference was a whopping 93 basis points -- almost a full percentage point.

Now, though, the spread is 60 basis points. That's only a tad larger than the 51 basis point average for the last two years. But it is widening.

What kind of money can you save right now with a 5/1 hybrid ARM? Let's look at a $150,000 mortgage to find out:

At the current fixed rate of 7.34 percent, the cost would be $1,032.43 a month for principal and interest. But at 6.74 percent, a 5/1 ARM would cost just $971.90, a monthly savings of $60.53. That's not a lot of money to some people, but it's more than enough to make or break the deal for many others.

What's more, over the five-year fixed portion of the loan, the interest savings would amount to $4,532.77 ($53,644.71 vs. 49,111.94). And that's not chump change for anyone.

Of course, you're taking a chance that mortgage rates in five years won't be too much higher than they are now. But now that borrowers have the ability to refinance almost at will with very little cash out of their own pockets, that's not as much of a gamble as it used to be.

Under the House bill, moreover, the first interest rate adjustment on FHA 3-1 and 5-1 ARMs cannot exceed 1 percent. On most conventional mortgages, the rate can move to the rate at the time of adjustment, no matter how big a jump that might be.

Overall, the subcommittee voted to increase the HUD budget for fiscal 2002 to $30 billion. That's an increase of $1.4 billion over the current budget authority, but it's still $550 million below what the President had asked for. Fiscal '02 begins Oct. 1.

Cut severely are credit subsidies for FHA multi-family mortgages. In keeping with HUD recommendations, the subcommittee approved just $15 million for the program, compared to $101 million in FY '01. HUD plans to make up the difference by increasing premiums on government-backed apartment and condo loans from 0.5 percent to 0.8 percent, effective Aug. 1.

Not all programs were slashed, however. In fact, the Sec. 202 housing for the elderly program was funded at the requested $783 million ($4 million above FY '01) and the Sec. 811 housing for the disabled program was funded at $23 million above what the Administration wanted (and $29 million above this year's budget).

The panel also decided to increase the Housing Certificate Fund, which covers Sec. 8 renewals and tenant protections by $1.8 billion over the current level. The total of $15.7 billion for FY '02 includes $197 to fund 34,000 new Sec. 8 vouchers.

In addition, the Office of Federal Housing Enterprise Oversight, the independent office within HUD which oversees the safety and soundness of Fannie Mae and Freddie Mac, is funded at $23 million. That's $1 million more than the current budget authority, but $4 million below the President's request.

For more articles by Lew Sichelman, please press here.

Published: July 17, 2001

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When Lew Sichelman first started writing about housing in 1969, he was the youngest real estate writer in the country. Now, 37 years later, he's one of the oldest -- and most decorated. He has been rated the top housing columnist in the country by the National Association of Realtors as well as by his peers in the National Association of Real Estate Editors. Indeed, NAREE has recognized his work on numerous occasions. One year - due to his advancing age, he can't recall which one - he earned top honors in the annual NAREE Journalism Contest in three out of the four major writing categories. It was the first time one writer has won so many NAREE awards in a single year. Known for his ability to make even the most difficult topics understandable, Sichelman also has been honored by the National Association of Home Builders and the Mortgage Bankers Association. He began providing in-depth coverage of and consumer-oriented information about housing and housing finance at the Washington Daily News, where he was real estate editor. He held that same position for nine more years at the Washington Star, which purchased the News in 1972. The Star, a so-called "writer's newspaper" which also had the misfortune of being an evening paper, was put out of its misery in 1981, and Sichelman, who had begun self-syndicating his column in 1978, decided to become a full-time columnist. Today, his column, "The Housing Scene," is distributed by United Media to newspapers throughout the country. He also is on the staff of National Mortgage News, an independent newspaper which is considered the bible of the mortgage business. And he writes for numerous other publications, including MarketWatch.com, where he answers readers questions once a week, Sports Illustrated (don't ask), RealtyTimes.com, BigBuilder and others. Sichelman is married, the father of five and grandfather of eleven.