Mortgage choice and the pricing of fixed-rate and adjustable-rate mortgages

In the United States throughout 2009, the share of adjustable-rate mortgages among total mortgage originations was very low, apparently reflecting the attractive pricing of fixed-rate mortgages relative to ARMs. Government policy could have changed the relative attractiveness of the fixed-rate mortgages and ARMs, thereby shifting the market share of these two housing finance instruments. One of the notable features of the current U.S. mortgage market is the predominance of fixed-rate mortgages. The interest rate differential between fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs) has fallen from a recent high of about 2.5 percentage points in the summer of 2004 to about 0.5 percentage point at the end of 2009. These changes in the interest rate differential have coincided with the collapse of mortgage securitizations other than those mediated by governmentsponsored enterprises (GSEs), including Fannie Mae, Freddie Mac, and Ginnie Mae (see Krainer 2009). In addition, the Federal Reserve began large-scale purchases of GSE mortgage-backed securities (MBS) starting in January 2009, adding significant secondary market demand for fixed-rate mortgages. The Fed’s purchase program has not included MBS containing ARMs. This Economic Letter reviews some of the factors determining consumer mortgage choices. It shows that