The Rise of ARMs.(Adjustable rate mortgages)

The Mortgage Bankers Association released some stunning data in early May that may have ominous implications for mortgage servicers. Adjustable-rate mortgages and interest-only products accounted for 63% of mortgage originations in the second half of 2004. After years of predominantly fixed-rate lending - much of it refinancing - the rise of the ARM and IO market likely will be a big factor in the performance of residential mortgage loans going forward.

The MBA survey found that refinancing slipped in the second half of last year, with home purchase lending accounting for 51% of loans in the second half, compared to 41% in the first half.

The MBA's chief economist noted that the shift to ARMs is nothing new when long-term interest rates start rising. In fact, it happens at the end of every refinancing boom, he said. But the MBA also noted that the shift to ARMs was sparked by a much smaller rate increase than would typically have been expected based on previous experience.

That, and the rise of IO lending, suggest that consumers are choosing loan products that minimize the monthly payments, especially in the early years of a loan, in order to stretch their buying capacity. This isn't surprising, given the run-up ...