According to Fitch Ratings, 90 percent of Reverse Mortgage Backed Securities (RMBS) contain fixed interest rates for their full term this year, meaning U.S. mortgage borrowers still choose fixed-rate mortgages as their loan of choice. Fitch notes that even with the upcoming termination of the London Interbank Offered Rate (LIBOR) in 2021, the most commonly used index for U.S. adjustable-rate mortgages (ARMs).
The percentage of RMBS containing fixed rate mortgages increased from 80 percent to 90 percent year over year in 2018, with Fitch noting that market interest rates for ARMS have “not been highly compelling.” According to Fitch, “hybrid” form ARMS, or those with fixed rates for the first five or 10 years, after which they adjust based on movements in LIBOR, have been impacted by slow moving long term rates. Current seven-year hybrid ARM rates are typically only 0.25 percent to 0.375 percent lower than available fixed-rate loans, which Fitch notes is not enough to entice borrowers.
Though most borrowers tend to lean toward fixed rate loans, for non-prime mortgage borrowers, hybrid ARMs are an attractive lending alternative as even small differences in mortgage rates can increase affordability during the initial level payment period. Currently, over 50 percent of non-prime loans currently being originated are five- to 10-year hybrid ARMs with LIBOR cited as the reference index for the adjustable term.
With LIBOR no longer available to mortgage servicers once these new hybrid loans roll to adjustable-rate, the mortgage and securitization documents allow for replacement. Just five percent of RMBS include an unpaid principal balance floating off of LIBOR. The end of LIBOR gives RMBS programs the opportunity to explore alternative options.
“Typically the note holder or servicer will choose a new index based upon comparable information and will give notice of this choice,” said Fitch. “Servicers are expected to make applicable interest rate adjustments in compliance with servicing standards and document references to an alternative index for the affected mortgage loans.”