Here Are 15,582 Reasons ARM Loans Are Getting Popular

That’s how much you could save over the next five years if you take out a popular type of adjustable-rate mortgage versus a more traditional fixed rate loan, now that fixed rates have risen so much.

Because the initial interest rate for a 5/1 adjustable rate mortgage (ARM) is averaging 1.32 percentage points less than for a 30-year fixed mortgage (5.30% versus 3.98%,) the average monthly payment for a typical house bought with a 5/1 ARM would be $260 smaller than with a 30-year mortgage over the first five years, real estate company Redfin said in a report released Friday. The substantial discount is the biggest a homebuyer would have had for any week since at least 2015, the period covered by Redfin’s analysis. And that explains why ARMs have gotten more popular lately despite the risks that go along with them.

Indeed, while the $260 translates to a savings of $15,582 over the first five years, there is a catch. Unlike with a fixed-rate loan, the borrower only gets a fixed rate for five years, and then it’s adjusted once a year for the rest of the mortgage’s life. The adjustment is based on a benchmark rate such as the Secured Overnight Finance Rate, leaving borrowers with the risk of their payments increasing if rates rise. Not only that, but for certain ARMs, borrowers could face penalties if they refinance or pay the loan off early. 

"Adjustable-rate mortgages can work really well for homebuyers who plan to stay in their home for less than 5 to 10 years and have the means to cover higher payments when the loan resets,” said Arnell Brady, a senior loan officer for Bay Equity Home Loans who was cited in Redfin’s report. 

Locking in a 30-year fixed mortgage rate was highly appealing when rates were at record lows earlier in the pandemic, but now they are hovering near their highest in over a decade. The recent spike, combined with relentlessly higher home prices, has left prospective homebuyers increasingly desperate to find ways to afford a home costing hundreds of dollars more a month. Last week ARMs made up more than 10% of all mortgage applications, more than triple the share in January, according to data from the Mortgage Bankers Association. 

What the average 30-year rate will be in five years is anyone’s guess. The Mortgage Bankers Association projects it will drop to 4.4% by the end of 2024, but did not even venture to predict what the economy might be like in 2027, when today’s 5/1 ARMs will be adjusted.  

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