ARMs are making a comeback as housing affordability issues and rising mortgage rates drive more buyers toward adjustable rate mortgages, which often offer a lower starting interest rate. “With rates on fixed-rate mortgages approaching 6% and likely higher for less qualified buyers, getting an ARM to get a rate below 5% seems much more attractive,” says Kate Wood, real estate expert at nerd wallet. Indeed, rates on 5/1 ARMs average around 4.3%, according to data from Bankrate. You can see the lowest rates you could qualify for here.
Data from the Mortgage Bankers Association shows that the share of ARM apps is now more than 10%, up from less than 4% at the start of this year. Additionally, “as of March 2022, ARM’s share accounted for 13% of conventional single-family mortgage dollar volume, a threefold increase since January 2021,” Corelogic notes. And the popularity of ARMs may continue, as many pros say mortgage rates will rise: “If mortgage rates on fixed-rate mortgages continue to rise, “the share of loans issued with an ARM will likely rise as well,” concludes Corelogic.
What is an adjustable rate mortgage and how does it work?
First of all, adjustable rate mortgages are just that – adjustable, meaning the interest rate and monthly payment fluctuate. Then, when the introductory period expires, the interest rate adjusts to current market rates. With a 5/1 ARM, the interest rate is fixed for the first 5 years, then switches to an adjustable rate for the remaining 10 or 25 years.
Who is an adjustable rate mortgage for?
The main candidates for an ARM are borrowers who plan to sell before the end of the fixed rate period of the ARM (this period is generally 5 to 7 years), thus not exposing themselves to the risk of a possible rising rates, says Scott Krinsky, a partner at real estate law firm Romer Debbas. “This also includes cash-rich borrowers looking for short-term access to additional funds at the lowest possible rate and with the ability to pay off the mortgage before any potential rate hikes,” Krinsky says. . You can see the lowest rates you could qualify for here.
And Jacob Channel, senior economist at LendingTree, says those who might be considering ARMs want lower introductory rates than they would find on a 30-year fixed-rate mortgage and don’t mind their monthly mortgage payment changes over time.
What are the advantages and disadvantages of an adjustable rate mortgage?
The lower introductory rate is the big advantage of an ARM, and furthermore, if rates drop after your fixed introductory period, you could end up with a lower monthly payment than you started with. You can see the lowest rates you could qualify for here.
On the other hand, ARMs are much more unpredictable than fixed rate mortgages and if rates go up, your monthly payment can become significantly larger. “If rates continue to rise, once the introductory period is over, someone with an ARM could end up spending more money than they would have had they gotten a low-rate mortgage. fixed,” says Channel.
While an ARM could be beneficial for borrowers who only plan to be in a home for 5-7 years, even this scenario is not without risk. “If your schedule changes, you could find yourself in a loan that will go up in price and increase your monthly payments and there’s no guarantee you can refinance under more favorable terms years from now,” says Greg McBride, financial analyst in Head at Bank Rates.
That’s why, says Channel, “it’s important for anyone considering an ARM to make sure they have enough money to handle a situation where their rate goes up and they need to spend more on their loan. mortgage”. Raising a mortgage rate by just one percentage point can increase your monthly mortgage payment by well over $100, depending on factors such as where your rate ends and the size of your mortgage. mortgage.
Because adjusting rates may present more risk to the borrower, Paul Thomas, Zillow’s vice president of capital markets for mortgages, says, “The unknown potential increase may make it difficult to budget for this loan. But new regulations enacted after the housing crisis have improved underwriting standards and transparency for ARM products, helping to improve a borrower’s ability to repay the loan after rates reset.