By Kerry Smith
In exchange for that savings, however, buyers accept risks. Adjustable rates reset at a future point, and interest rates could be uncomfortably higher when they do.
SEATTLE – When the average 30-year, fixed mortgage rate hit record lows over the past few years, adjustable-rate mortgages (ARMs) seemed to have completely disappeared. But as rates rise, more buyers are considering ARMs as a way to offset higher costs.
According to an analysis by Redfin, the typical homebuyer could save an estimated $15,582 over five years – roughly $260 per month – by taking out an adjustable-rate mortgage rather than a 30-year-fixed-rate mortgage (FRM).
In savings terms, it’s the largest amount of money since at least 2015.
For the analysis, “typical” is based on estimated monthly mortgage payments for a median-asking-price home during the four weeks ending May 12, comparing the 30-year fixed mortgages and 5/1 adjustable-rate mortgages (ARM).
A 5/1 ARM offers a fixed interest rate for five years, and then a varying rate that adjusts once per year, usually for a 30-year loan. However, ARMs vary. A 7/1 offers a fixed rate for seven years, though the initial guaranteed rate is likely higher than the one for a 5/1 ARM.
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 – roughly 11% ($260) lower per month than the $2,423 estimated payment for buyers who took out a 30-year FRM.
The week of May 12, the average interest rate on a 5/1 ARM was 3.98% compared to a 5.3% average rate on a 30-year FRM. It’s a spread of 1.32 percentage points, or just shy of the 1.36 percentage-point spread during the week ending April 21, which was the largest since 2014.
About one in 10 (10.8%) of loan applications as of May 6 were for an ARM, up 3.1% from the start of the year and the highest percentage since 2008, when a lack of ARM regulation helped contribute to the housing crash.
In the early 2000s, scores of borrowers were drawn to ARMs offering low initial “teaser rates” and sometimes a 0% down payment. But when those ARMs later reset to a higher interest rate, many of those borrowers could no longer afford their monthly payment. Today’s ARMs are generally safer, in part because federal regulations grew tougher following the Great Recession, and lenders today learned a lesson from those mistakes.
Still, ARMs come with a big risk: No one can predict where interest rates will be five years in the future. If they’re significantly higher, it still might be harder for borrowers to cover their monthly mortgage. For certain types of ARMs, borrowers may even face fees or penalties if they refinance or pay off their loan 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,” says Arnell Brady, a senior loan officer Bay Equity Home Loans.
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