Adjustable Rate Mortgages Rise in Popularity

HOUSTON – (By Dale King, Realty News Report) – Would-be homebuyers have spent the better part of two years trying to overcome obstacles standing in the way of purchasing a domicile of their very own.

The COVID pandemic initially cut off free access to viewing homes on the market. And long before the global viral infection abated, the cost of houses on the “For Sale” market rebounded – and skyrocketed.

While over-the-top prices have just begun to chill a bit, another speed bump has emerged on the road to home ownership – record-high mortgage rates.

Real estate brokerage Redfin has stepped in with a suggestion to help potential purchasers sidestep a major monthly mortgage payment likely to tally as much as $2,427 a month, a record high average figure up 44 percent from $1,685 a year earlier, according to the company’s figures.

The money-saving answer is to go with an adjustable-rate mortgage, or ARM. Redfin says a typical homebuyer could save an estimated $15,582 over five years, or roughly $260 per month, by taking out an adjustable-rate mortgage rather than sign up for a 30-year-fixed-rate payment schedule. That’s the largest savings in dollar terms for adjustable-rate mortgage holders since at least 2015, according to Redfin’s analysis.

“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 of Bay Equity Home Loans — Redfin’s mortgage company.

Brady said that 20 to 30 percent of his clients are now asking about adjustable-rate mortgages, a significantly larger share than before the pandemic. “As mortgage rates surge, demand for ARMs is on the rise because they typically have lower interest rates than 30-year fixed loans.”

Redfin’s analysis is based on estimated monthly mortgage payments on the median-asking-price home during the four weeks ending May 12 for 30-year fixed mortgages and 5/1 adjustable-rate mortgages.

A 5/1 ARM is a loan in which the interest rate is fixed for the first five years and then adjusts once a year for the remainder of the loan term — typically 30 years. Borrowers can also choose ARMs in which the interest rate resets after seven years, 10 years and other durations, but Redfin’s analysis focused on 5/1 ARMs —one of the most popular types.

The Redfin report shows that typical monthly mortgage payments in May 2015 were at $1,250 or just under. They remained in and around $1,500 a month until early 2022. Just this month – May 2022 – these rates shot upward.

Mortgage rates hovering just above 6.4 percent in May of 2003. They fluctuated but stayed mainly in that area until the bottom dropped out of the market between 2008 and 2010. Rates remained generally low until May 2022 when the 30-year fixed rate hit 5.3 percent and the 5/1 ARM came in at 3.98 percent.

The typical monthly payment for buyers who took out a 5/1 ARM was an estimated $2,164 during the four weeks ending May 12. That’s roughly 11 percent ($260) lower than the $2,423 estimated typical payment for buyers who took out a 30-year fixed-rate mortgage.

Adjustable-rate mortgages come with lower interest rates, and therefore lower monthly payments, the Redfin report says, because buyers only get to lock in their mortgage rate for a certain number of years. They’ve been rising in popularity as mortgage rates have surged at their fastest pace in decades.

The average interest rate on a 5/1 ARM was 3.98 percent during the week ending May 12, while the average rate on a 30-year fixed mortgage was 5.3 percent—a spread of 1.32 percentage points. That’s just shy of the 1.36 percentage-point spread during the week ending April 21, which was the largest since 2014.

The Redfin analysis warns that ARMs are somewhat risky, as it’s challenging to predict where mortgage rates will be when the loan resets. If they’re significantly higher, it may be harder for borrowers to cover their monthly mortgage.

Also, for certain types of ARMs, borrowers may face fees or penalties if they refinance or pay off their loan early, says Redfin Deputy Chief Economist Taylor Marr. “If borrowers do consider refinancing, they should calculate whether the closing costs for the refinance negate the savings from the ARM,” he adds.

Adjustable-rate mortgages made up 10.8 percent of all mortgage applications during the week ending May 6. That’s up from 3.1 percent at the start of the year and the highest share since 2008, when a lack of regulation of ARMs helped contribute to the housing crash. Scores of borrowers were drawn to ARMs in the early 2000s due to their low initial “teaser rates” and option for a 0 percent down payment. That became problematic when rates reset higher, and many buyers could no longer afford their monthly payments.

Today, banks conduct more due diligence to check if buyers will be able to cover the increased costs when the loan resets. For example, Bay Equity Home Loans requires a down payment of at least 5 percent, a minimum credit score of 620 and a debt-to-income ratio of no more than 50 percent. There are also caps on how much lenders can increase interest rates.


May 23, 2022 Realty News Report Copyright 2022

Photo credit: Ralph Bivins Realty News Report Copyright 2022

File: Adjustable Rate Mortgages Rise as Buyers Seek Options

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