updated 7/26/2004 7:34:39 PM ET 2004-07-26T23:34:39

Lower-income and minority buyers are most likely to choose adjustable-rate home mortgages over fixed-rate loans but are especially likely to be hurt by the rising interest rates that often accompany ARMs, according to a survey released Monday.

The survey found that such home buyers understand little about the interest-rate risks.

By contrast, about two-thirds of those surveyed in the poll by the Consumer Federation of America appeared to be aware of the risk of ARMs and said they preferred fixed-rate mortgages, the consumer group said.

Mortgage rates have been rising and are up by about a percentage point from a year ago, though they remain at historically low levels. Sales of existing homes rose 2.1 percent to set a record in June as ascending rates prompted a rush by Americans to close deals before rates went even higher, the National Association of Realtors reported Monday.

In fact, rates have backtracked a bit in recent weeks, with the 30-year mortgage falling to 5.98 percent last week, the first time it has been below 6 percent in three months.

ARMs picked by 30 percent of buyers
Adjustable-rate mortgages traditionally have been favored by more affluent home buyers who can afford mortgage rate increases, the Consumer Federation noted. But ARMs now are chosen by more than 30 percent of home buyers, and some lenders are marketing them to all potential buyers, regardless of income or assets, the group said.

“Lenders who aggressively market ARMs to lower-income consumers and those with low credit scores are acting irresponsibly,” said Stephen Brobeck, the group’s executive director. “Given the high probability of interest rate increases, an adjustable-rate loan made to a family which can barely afford the initial monthly payments represents a ticking time bomb.”

Heather McElrath, a spokeswoman for the American Bankers Association, said the trade group had seen no evidence of such aggressive marketing.

She said the benefit of ARMs for low-income and minority home buyers, who have lower rates of homeownership than the general population, is that “it does get them in at a lower cost.”

In many cases, these new homeowners see their income grow after they buy a house and therefore aren’t likely to be hurt by having chosen ARMs, McElrath said.

Numerous options
Home buyers have a number of options to lower borrowing costs. They can pay points upfront to buy down, or lock in, a mortgage rate. Or they can choose ARMs, which carry a lower rate but with the accompanying risk.

The most popular ARMs are the hybrid versions in which adjustable rates kick in after a fixed rate for the first three to 10 years. How long a buyer plans to stay in the home and how much financial risk the buyer can tolerate shape the decision.

For a mortgage hunter who expects to stay only seven years, about the average time people spend in a house, a 30-year fixed rate may not be the best idea. Five-year and seven-year ARMs have over the past year been running about 1 percentage point below the 30-year rate.

A buyer who contracts a loan for $200,000 at a 30-year fixed rate of 6 percent pays a monthly mortgage of $1,199.10. A seven-year ARM at 5 percent demands a monthly payment of $1,073.64, a savings $125.46 a month, or $10,500 over seven years.

The survey of 1,015 adults was conducted July 8-11. The margin of error is plus or minus 3 percentage points.

It found that 33 percent of respondents with annual incomes below $25,000 said they preferred ARMs to fixed-rate mortgages, compared with 20 percent of those earning more than $50,000. Thirty-seven percent of Hispanics and 31 percent of black respondents expressed a preference for ARMs, compared with 23 percent of whites.

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