In today’s rising rate environment, adjustable-rate mortgages (ARMs) are coming back. But these aren’t the ARMs your parents used in the early 2000s. Today’s offerings provide some added protection due to the lessons learned in the 2008 crash.
Back then, about 30% of mortgages were made with adjustable rates. This means the loan started with an interest rate lower than the market rate, then began floating with the market after a prescribed amount of time. Typically, the rate – and therefore the monthly payment – jumped much higher.
Often, as it turned out, the new payment was more than borrowers could afford. The logical answer was to get into a new, more affordable mortgage. But because many homes had lost value, many borrowers weren’t able to sell or refinance for the full amount they owed and lost their homes.
Why are homebuyers turning to ARMs again?
We’re in a housing market where home prices have been rising at their fastest pace, beginning even before we started talking about inflation in other areas. And now that inflation has settled in, the Federal Reserve Board is increasing the Federal Funds Rate to try to tame it. While the Fed rate does not directly impact mortgage rates, it does influence them. Combined with other geopolitical factors, the Fed’s stance is pushing mortgage rates higher.
With recent mortgage rate increases and several years of quickly rising home prices, Atlanta homebuyers are finding monthly housing payments to be more expensive than they were last year. ARM loans, with their lower initial rates, can help buyers get lower monthly payments for the homes they really want to buy.
How do today’s ARMs work?
The ARMs most borrowers are using these days are hybrid ARMs, appearing on rate sheets as 5/1 ARM, 7/1 ARM, 10/1 ARM, etc. These examples offer a low fixed rate for the first 5, 7, or 10 years then adjust at yearly intervals thereafter. When they adjust, the rate shifts to a specific market rate plus an added margin.
Today’s ARMs offer caps so borrowers know how high their rates might go. The three types of caps limit the amount the rate can increase in the initial adjustment, at each subsequent adjustment, and over the loan lifetime.
Lenders are more careful today than they were before the crash, too. Borrowers now must have higher credit scores and provide more documentation, demonstrating their ability to repay.
In the Mortgage Banker Association’s June 22, 2022, weekly survey of mortgage applications, 10.6% were for ARM mortgages, far lower than the percentage in the early 2000s, but higher than any time since 2008.
Is the risk worth the payment savings?
Experts typically recommend ARMs in a few scenarios. First, they work best for homebuyers who expect to move before the initial adjustment takes place. Second, they make more sense on pricier homes, where the total savings will be more; it may not be worth the risk for small monthly savings on a smaller loan. Third, it can be less risky for buyers who take a longer initial fixed term. The interest rate on a 10/1 will be higher, but it will offer more time to get into a new home or a new loan if needed. Finally, the risk is best for borrowers who can make a sizable down payment. That way, if home values fall as they did after the 2008 crash, borrowers are more likely to maintain sufficient equity to sell or refinance.
ARMs are not for everyone, but in the right scenario, they can make the difference in getting into the preferred new home at a comfortable payment. As always, it pays to talk to a mortgage advisor early in the home shopping process.