The recent announcement from the Federal Reserve that they raised The Fed Fund Rate by 25 basis points has been part of what refueled borrowers’ interest in adjustable-rate mortgages (ARMs), along with the rising mortgage rate environment. The volume of ARM mortgage applications increased for the third straight week last week, according to the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending March 17, because many homebuyers are struggling to find an affordable mortgage in a rising-cost mortgage environment.
Continued ARM applications come as the yield curve inversion remains, a banking crisis potentially looms (at the very least, a crisis of confidence exists), and The Fed continues to raise rates. Traditionally, this combination leads to job losses and recessions…but not always. Yet, many prospective homebuyers simply feel like they have to get in the homebuying game now, or else price and interest rate escalations may push them further and further out of achieving the American “dream” of homeownership (should a recession actually not fully materialize). And many are seeing the only solution to breaking down the home affordability barrier is ARMs.
Interest Rates Remain Near Their Highest Level in a Decade.
Interest rates today are close to the highest that they have been in a decade. When interest rates were at historic lows during 2020, and up until early 2022, many buyers could offset high home prices with affordable monthly mortgage payments. Now, with soaring interest rates and high home prices, what are some buyers to do? Borrowers must seek the lowest possible interest rate to make the monthly payment affordable and within their budget – even if that rate drop is potentially only temporary.
So, what can buyers do now to buy a new home at an affordable price? Some would-be buyers are considering the adjustable-rate mortgage to secure a mortgage with an initial monthly price they can better afford.
Yet, everything comes at a price. Today, opting for an adjustable-rate mortgage may mean swapping the near-term savings for higher costs when the mortgage adjusts to the current rate at the end of the ARM term.
ARMs Can Put Borrowers in Win or Lose Positions Later.
For many homebuyers, an ARM might seem attractive right now, but before deciding to pursue that option, a buyer must consider the alternatives. If the interest rate on the mortgage climbs (especially at the time that their initial ARM term expires), making the loan payments far more expensive, that can put borrowers in a risky position. With a fixed-rate mortgage, borrowers do not have that risk.
Most people sign an ARM with the intent to refinance their mortgage when mortgage interest rates drop. But no one knows what is in store for mortgage rates in the next three or five years. Risky! Especially since refinancing is not automatic and homebuyers should try to meet the following requirements in order to qualify for the refi: have at least 20% equity, have a 620+ credit score (for a conventional loan), and have a DTI below 50%. And don’t forget the refinancing costs which can be between 2% – 6% of your loan amount.
Of course, the other side of the coin is that the rate at the end of the ARM “teaser period” isn’t necessarily going to increase. It could actually drop over time, making mortgage payments less expensive on a monthly basis without the borrower actually having to do anything. And assuming their credit worthiness is maintained and the fees do not offset the interest rate reduction, this process can be a real financial win for many ARM borrowers.
There is no crystal ball when it comes to predicting future mortgage interest rates, it is a safe bet that interest rates will eventually fall.
While fixed interest rates remain (relatively) high, adjustable-rate mortgages will continue to come back. As financial markets fluctuate and the economy remains volatile, some borrowers may regret their decision.
Close to Half of ARM Borrowers Regret Their Decision, But More + More Are Interested in Securing Them.
About 43% of those who took out an ARM regretted it, according to a recent survey by U.S. News & World Report.
Yet new homebuyers don’t seem to be paying much attention to ARM borrowers’ dissatisfaction, as a recent survey by ROCKET Mortgage found that 40% of Americans say they would get an ARM. Meanwhile, the share of ARMs accounted for less than 2% of mortgage applications in 2021 and rose to 13% in 2022 according to The Mortgage Bankers Association.
Of course, in a high interest rate environment, some borrowers will continue to seek the most affordable loan for their budget, but it appears opinions are mixed when it comes to satisfaction with an ARM. Maybe a buydown is a better option? We will explore the 2-1 interest rate buydown in a future blog.