Sam Gendusa July 6, 2022

Newsletter - July 2022

With interest rates climbing and home prices still sky high, adjustable-rate mortgages (ARMs) are on the rise.

The 30-year fixed mortgage rate hit 5.30% last month — compared to 3% a year ago — significantly increasing the cost of financing a home.

In May 2021, the monthly payment on a $300,000 home, with 80% financed through a 30-year fixed mortgage, would be $1,267 according to numbers from Freddie Mac.

Today, that payment would be $1,660 — a difference of about $400 per month — and interest rates aren’t likely to go down any time soon.

With a national average interest rate of 4.49%, it’s easy to understand why more borrowers are opting for 5/1 adjustable-rate mortgages.

With an ARM, buyers can get that lower interest rate for the first term of their loan (usually 5, 7, or 10 years). But while that makes homeownership more affordable at the beginning, it can be risky.

Once the term is up, the interest rate adjusts to the current market rate. That could be lower — or higher — and can change annually after that.

ARMs got a bad name during the housing bubble of the mid-aughts, when they were offered to borrowers who couldn’t afford payments with a 30-year fixed loan.

“If you’re looking at an adjustable rate as a crutch for affordability, that’s a red flag,” said Bankrate’s chief financial analyst Greg McBride. “A 30-year fixed-rate mortgage may not always be the optimal loan, but it’s your best gauge of affordability.”

Adjustable-rate mortgages accounted for almost 45% of originations in 2005, then dropped to single digits after the bubble burst in 2007. Since then, the share of ARMs has mostly fluctuated between 8%-18%, but declined during the pandemic (thanks to those record-low 30-year rates), hitting a 10-year low of 4% in January 2021.

In March of this year, ARMs had increased to 13% of single-family mortgage originations.

Is this a sign of bad things to come?

Not necessarily, especially since adjustable-rate mortgages are regulated more heavily these days. There are limits on how much higher an ARM can go now, which makes them slightly less risky.

And “banks will make sure you qualify,” said Melissa Cohn, regional vice president of William Raveis Mortgage. “It’s a whole different marketplace.”

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