3 things agents should know about adjustable rate mortgages
With fixed-rate mortgages expected to remain elevated into 2027, more homebuyers may turn to ARMs in pursuit of lower monthly payments.
Key points:
- As elevated mortgage rates stay above 7%, more consumers are opting to use ARMs — a mortgage product that has become less risky since the 2008 financial crisis.
- Around 11% of all loan applications were for ARMs as of late October, according to the Mortgage Bankers Association. If fixed 30-year rates stay high, that share could grow.
- For buyers struggling to afford a home, the savings from an ARM may make a big difference at first. But those initial payments won’t last forever, and future rate levels are uncertain.
With elevated fixed-rate mortgages continuing to make homebuying difficult for everyday consumers, more are pondering the possibility of using adjustable rate products.
The share of borrowers opting for adjustable rate mortgages (ARMs) continued to rise this fall, averaging around 11% of all loan applications as of late October, according to the Mortgage Bankers Association. Optimal Blue has estimated that ARMs accounted for 17% of the total lock volume last month, up from 14% in September and the highest share dating back to 2019.
The use of ARMs was sharply curtailed following the 2008 financial meltdown, when lax rules for subprime hybrid ARMs led to situations in which falling home prices and rising rates put many borrowers in a spot where they couldn't refinance or sell without taking a loss.
Changes made to ARMs following the Great Recession have resulted in a less risky product, allowing more buyers in this current high-rate environment to consider using them — particularly those who expect to move within five to seven years.
Below are three factors real estate agents should keep in mind if a client brings up the possibility of choosing an ARM as the mortgage option rises in popularity.
How are ARMs different now compared with 2008?
First American Deputy Chief Economist Odeta Kushi, who recently conducted research on the topic, said today's ARMs generally have longer initial fixed-rate periods, limits on how much rates can adjust and stronger underwriting requirements. While these changes have cut down some of the risks, it's still possible that interest rates will rise after the fixed period ends.
In an email to Real Estate News, Kushi said agents should encourage buyers to explore all of their financing options. "For some buyers, particularly those who expect to move before the initial fixed-rate period ends, an ARM can be an attractive option because it provides a lower initial rate and a predictable payment during that fixed period," Kushi said.
"But buyers should understand when the rate can adjust, how much their payment could increase, and whether that future payment would still fit their budget," she added. "Refinancing may be an option down the road, but future mortgage rates are uncertain, so buyers shouldn't count on it."
Will ARMs become more popular?
Kushi believes there is room to grow the ARM share, particularly if large gaps between fixed-rate mortgages and ARMs remain.
Currently, the rate for a 5/1 ARM — a 30-year loan that charges a lower rate than a 30-year fixed rate for the first five years before adjusting once a year for the remaining 25 years — is about 1 percentage point below the 30-year fixed rate, she noted. On a $400,000 mortgage, that's roughly a $270 a month difference initially.
"For buyers struggling with affordability, those savings can make a difference. And historically, we've seen ARM share rise when the gap between fixed and adjustable mortgage rates widens," Kushi said. "If that gap persists, I would expect ARMs to remain attractive to prospective buyers, with the potential for their share to climb further."
Are ARMs only popular when fixed rates are high?
Elevated mortgage rates are the biggest driver for ARMs, but Kushi said there are other factors at work, including ARM product availability.
"When lenders expand their offerings, more borrowers have the option to choose an ARM, potentially increasing its share of mortgage applications," Kushi said.