The dramatic rise of the yield on the 10-year Treasury has pushed fixed-rate loans up by about 80 basis points (bps) in the span of just two months.
The rising rates are beginning to cut into proceeds, causing some acquisitions to be renegotiated on the fly in January to account for the new normal. Fannie Mae uses a 5.5 percent rate in sizing 10-year loans, and as all-in rates bump up against that mark, proceeds are beginning to shrink.
Yet LIBOR, the benchmark for setting adjustable-rate loans, has remained low. The one-month LIBOR rate has stayed below 30 bps since September, and the three-month rate continues to hover around 30 bps, as of early January.
Does that mean that an adjustable-rate mortgage (ARM) is a better bet than a fixed-rate one right now?
“Given the rise in the 10-year Treasury, we’ve seen loan proceeds negatively affected, so people are exploring ARMs,” says John Cannon, an executive vice president at Horsham, Pa.-based Berkadia Commercial Mortgage. “That said, most people are doing just that, exploring. The vast majority is still going through with fixed-rate executions.”
Weighing the Options
Floating-rate loans allow for more flexible prepayment terms, yet many borrowers are still looking to lock a rate for the long term. And 10-year rates from the government-sponsored enterprises (GSEs) are still low by long-term historical standards, at around 5.5 percent in early January. So while all-in rates are up nearly 100 bps from early November, they’re still low enough to offer some peace of mind.
“You could probably ride the LIBOR wave for another year or so,” says Mark Wilsmann, managing director at New York-based MetLife. “But I think that three years from now, most people won’t regret locking up the long-term fixed-rate financing.”
And the yield on Treasury notes may be a bellwether—many feel that it’s only a matter of time before LIBOR follows suit. “If the consensus is that rates are going to continue to rise, that’s going to make a lot of people on ARMs nervous, even if the rates are that much better,” says Don King, national production manager at Boston-based CWCapital.
Many are waiting to see if Treasuries bounce down again in January before exploring ARMs. But if the discrepancy between fixed and floating rates reach a critical mass, it would be impossible for borrowers to ignore adjustable-rate executions.
“If floating rates stay low and fixed rates continue to increase, you’ll see people move back to ARMs,” King says. “Fixed rates are still low enough. But I don’t know what the break point is going to be.”
Freddie Takes the Cake
Either way, Freddie Mac seems well poised in this interest-rate environment. The company’s Capped ARM program doesn’t see much competition from Fannie Mae. And in general, Freddie takes a different approach from Fannie in sizing fixed-rate loans.
“One advantage that Freddie does have is there’s no underwriting floor, and Fannie still has the 5.5 percent floor,” says Will Baker, a vice president at Bethesda, Md.-based Walker & Dunlop. “So sometimes Freddie’s proceeds may be a little bit better than Fannie’s.”