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Rising Mortgage Rates Cause 'Rush to ARMs'

After hovering around record lows for the past few years, mortgage rates are rising dramatically. That has consumers not only shopping more but also considering adjustable rate mortgages, which offer lower rates and lower monthly payments.

These ARMs, many requiring interest payments only, were popular during the latest housing boom but quickly fell out of favor when safer, fixed-rate loan rates fell to record lows. ARMs accounted for 36 percent of mortgages in 2006 but just 4.5 percent today, according to Lender Processing Services.

The shift to ARMs is not visible on a grand scale yet, but it is beginning.

The average contract rate on the 30-year fixed rate rose to 4.46 percent from 4.17 percent, the Mortgage Bankers Association said Wednesday. At the beginning of May, rates were as low as 3.5 percent. Concern that the Federal Reserve will begin to pull back on its purchases of mortgage-backed bonds, which pushed rates so low in the first place, caused the most recent spike.

"Mortgage rates increased by the most in a single week since 2011, and refinance application volume dropped to its lowest level in almost two years. However, applications for conventional purchase loans picked up by more than 3 percent over the week," the MBA's Michael Fratantoni said.

Mortgage applications to purchase a home are rising for two reasons: Buyer demand is increasing, and those buyers are afraid rates will go up dramatically, so they want to lock in fast.

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Alicia and Ryan Diederichs say they are in a race against time. A job transfer recently sent them and their three young children to Oceanside, Calif. Now crammed into a small rental apartment, they are hoping to buy a house quickly.

"I'm afraid we're going to miss the boat," said Alicia Diederichs. "I feel like we might get priced out of the market in a few months, and just depending on the mortgage payment whether we could afford it if the interest rates go up more."

The Diederichs need a large house to fit their family, but home prices are rising fast on the California coast, and they have not yet locked in a mortgage rate.

"Ideally we would do a 30-year fixed, but it's all going to be dependent on the end mortgage payment, what we can afford, so we would have to look at an ARM potentially if rates continue to rise," she said.

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The combination of sharply higher home prices and rising rates is squeezing buyers who are already facing tighter underwriting standards. In order to qualify for loans, they must fit into strict debt-to-income calculations, and those calculations change with every increase in mortgage rates.

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"I think you're seeing much more intense shopping where people are comparing rates between lenders, but also looking at different less conventional products," said Glenn Kelman, CEO of Redfin. "They're getting teaser rates, they're buying it down, they're trying different things to try to get back to the rate they saw last week."

Some buyers are also being forced into adjustable rate loans in order to save deals that may have blown up in the past few weeks due to the rise in rates.

"Funny, people are rushing into higher-risk loans to save deals as rates spike. What happens in five years when their rate starts adjusting upward 2 percent per year? They blow up!" said Mark Hanson, a California-based mortgage and housing analyst.

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Hanson cautions that this may not be a "return to ARMs," in general, but more of a "rush to ARMs" in the past four weeks. ARMs are harder to qualify for, and the rate on the 30-year fixed, while higher, is still historically low.

Rising rates will push some into riskier, adjustable-rate products, "whereas others will view rising rates as a sign that they need to lock in to a 30-year fixed now before rates move higher," said Craig Strent, CEO of Maryland-based Apex Home Loans.

By CNBC's Diana Olick. Follow her on Twitter @Diana_Olick or on Facebook at facebook.com/DianaOlickCNBC.

Questions? Comments? RealtyCheck@cnbc.com.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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