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HALF OF U.S. MORTGAGES WERE ARMS IN 1994

Last year, when fixed-rate mortgages seldom dropped below 9 percent, one of every two homebuyers chose an adjustable rate mortgage.

ARMs were most popular in the two states with the most expensive houses, according to the Federal Housing Finance Board.In Hawaii, where the average purchase price was $284,000, fixed-rate mortgages accounted for just one-third of the financing, while 67 percent of buyers chose ARMs. In California, with an average sales price of $220,800, the ARM rate was 63 percent.

Nationally, the Finance Board said, 55 percent of buyers who got a conventional mortgage (as opposed to one insured by FHA or VA) chose ARMs.

Mortgage rates this spring are below 9 percent, but not by much. The national average, according to the Mortgage Bankers Association, is 8.58 percent.

Many buyers still are finding the one-year ARM attractive because its initial rate - 6.64 percent nationally this week - is about 2 percentage points below the fixed-rate mortgage.

Unless interest rates fall substantially in the next year, though, the second-year rate on the ARM will be above 8 percent.

An alternative for those seeking a low starting rate might be a five-year balloon. Although the balloon ends after five years, requiring you to refinance, it's perfect if you know you'll be moving before the mortgage runs out.

Right now you can get a five-year balloon at an interest rate of 7.87 percent, according to the Mortgage Bankers. That's just 1.2 percentage points above the one-year ARM and the rate is locked in for five years.

The difference in the monthly payment between the one-year ARM and the five-year balloon would be about $100 - a little less for smaller mortgages, a little more for larger mortgages.

In the second year, the ARM would be more expensive unless interest rates fall dramatically over the next 12 months. However, even if the ARM rose the maximum 2 percentage points possible - from 6.64 percent to 8.64 percent - you'd still be slightly ahead for the two-year period.

It's in the third year that the real benefits of the five-year balloon would be apparent.

For example, consider a $130,000 mortgage, which is about the average loan size for those who chose balloon mortgages recently, according to the Mortgage Bankers.

The monthly principal and interest payments on a $130,000 ARM mortgage at 6.64 percent would be $833. That rises to $942 with the five-year balloon.

In the second year, the balloon payment remains at $942. If the ARM rose the full two points allowed on most contracts, the payment would spike up to $1,008.

Over the two-year period, the ARM owner would have paid an average of $920 - or $22 less than the average paid by the five-year balloon holder.

The following chart compares the monthly mortgage payment on a five-year balloon at 7.87 percent with a one-year ARM that starts at 6.64 percent and rises in the second year to 8.64 percent.

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ADDITIONAL INFORMATION

How rates compare for ARMs, balloons

Mortgage 5-Year Initial Second Year

Amount Balloon ARM ARM

$90,000 $ 652 $ 577 $ 698

$110,000 $ 797 $ 705 $ 853

$130,000 $ 942 $ 833 $1,008

$150,000 $1,087 $ 961 $1,164

$175,000 $1,268 $1,122 $1,358