by Calculated Risk on 3/30/2006 02:11:00 PM

The MBA noted this week that 28.7% of mortgage applications were for ARMs. That number seems very high and I'm wondering why borrowers are still using ARMs.

In the weekly Freddie Mac interest rate report, 'the 30-year fixed-rate mortgage averaged 6.32 percent' and the 'one-year Treasury-indexed ARMs averaged 5.41 percent' for the previous week.

Ignoring borrowing costs (slightly higher for ARMs), borrowers would save 0.91% in interest payments the first year by using an ARM. The margin on the ARM is 2.79%, so the current fully adjusted rate would be 7.62%. Usually the interest rate adjustment is capped to 1% per year, so the ARM borrowers would be paying 6.41% next year and 7.41% the following year (assuming rates stay steady).

So when would an ARM make sense? Here are some ideas:

1) If the borrower is only going to own the home for one or two years.

2) If borrowers expects interest rates to decline - the yield on the One Year treasury would have to decline from 4.8% to an average of 3.5% over the course of the loan to break even.

3) If the borrower is leveraging themselves into a more expensive home, expecting the extra home price appreciation to make up for the higher payments in the future.

None of these reasons make much sense to me in the current environment.