High mortgage rates drive borrowers to ARMs for savings, expert says

Homebuyers should know the risks of using ARMs

Homebuyers are looking to adjustable-rate mortgages (ARMs) to help them save, First American's chief economist said. (iStock)

Homebuyers vying to gain a foothold in the housing market are dealing with affordability issues such as high borrowing rates and home prices. With interest rates on fixed-rate loans on the rise, homebuyers may be weighing their options. 

For some, that could mean sidelining their search until prices or mortgage rates drop. Another option to consider is adjustable-rate mortgages (ARMs), First American’s Chief Economist Mark Fleming wrote in a blog post.

Compared to more traditional mortgage products, ARMs offer lower initial interest rates before adjusting to higher rates in the future. As of early September, the average rate for a 30-year fixed-rate mortgage was 5.94%, more than twice what it was a year ago, while an ARM averaged 4.81%, according to the Mortgage Bankers Association’s (MBA) weekly survey. 

"As affordability wanes, potential home buyers are looking to adjustable-rate mortgages for the lower rate benefit," Fleming wrote. "Given the lower mortgage rate that is typically offered on an ARM today, compared with the 30-year, fixed-rate mortgage, ARMs offer prospective first-time home buyers an option to recapture some house-buying power in a rising rate environment." 

If you are interested in taking advantage of the current mortgage rates, you could consider refinancing your loan to lower your monthly payment and save money over the life of the loan. Visit Credible to find your personalized interest rate without affecting your credit score.

ARMs give you more home buying power, expert says

This year, ARMs have experienced tremendous uptake, particularly in the spring and early summer, when 30-year fixed rates were rising and mainly above 5.5%, according to the MBA. In the first half of 2022, the share of ARMs nationwide rose from 3% to 10% of all mortgages, the highest percentage since before the 2008 housing crash.

Esther Phillips, director of sales at Key Mortgage Services said that the most potent allure of ARMs is that it helps consumers justify making their purchase or helps them keep the home they wish to buy within their monthly budget during a difficult rate period. This is because ARM loans can be considerably cheaper than fixed-rate mortgages in the short term, with lower monthly payments in the initial years of the loan.   

"Consumer house-buying power, how much one can buy based on average household income and a given mortgage rate, increases when the mortgage rate drops," Fleming wrote. "In fact, at those rates, an ARM increases consumer house-buying power by nearly $44,000 compared to a traditional 30-year, fixed-rate mortgage."

And Melissa Cohn, the regional vice president of William Raveis Mortgage, said that "more and more people are taking adjustable rates."

She added that the lower initial rates offered by ARMs allow more buyers to remain in the buyer pool who otherwise may be priced out by higher rates on fixed-rate mortgages. "They can look at ARMs or try and wait for better buying conditions, which may not happen for some time," she said.

If you want to take advantage of today’s mortgage rates, you can visit Credible to compare different rates and lenders and find the right option for you.

Some experts remain concerned about ARMs' risk

The risk with ARMs is that the rate -- and a borrower’s monthly payment -- will go up when the interest rate is adjusted periodically. Depending on how much the rate rises, it could end up being more than a fixed-rate loan in the long term. This can be especially risky for borrowers on tighter budgets who potentially could see their monthly mortgage payment stretch past the point of affordability.  

"The introductory rate is used as a carrot with the suggestion that you can refinance before the higher rates kick in," Erin Sykes, a real estate adviser and chief economist at Nest Seekers International, said. "This is very dangerous for the average homebuyer, especially when entering a time of economic uncertainty. "

Fortunately, today’s ARM is very different from the product credited with triggering the housing market crash of 2008, according to Fleming. He said that the product has evolved to offer a reduced risk of significant payment shock when the fixed-rate period ends and rates become adjustable. 

However, concerns around the product remain. Ran Eliasaf, founder and managing partner at Northwind Group, said that it's likely that if borrowers are struggling to afford a fixed-rate mortgage today, they will find it even more difficult 5 to 7 years from now. "If interest rates continue to rise and we enter into a recession, ARMs may leave Americans with unaffordable mortgages after their teaser rates expire," Eliasaf cautioned.

If you are considering buying a home and want to learn more about which mortgage product is right for you, visit Credible to speak to a home loan expert and get all your questions answered.

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