Mortgage rates continue to creep higher, compounding an affordability crunch that has squeezed many Americans’ wallets. Now, soaring rates are prompting some home buyers to roll the dice that they will fall in a few years.
The average 30-year, fixed-rate mortgage, the most popular home loan in the United States, rose to 7.28 percent this week, up from 6.34 percent a year ago and the highest level since November 2023, the mortgage financing giant Freddie Mac said Thursday. The rate last week was 7.03 percent.
Mortgage rates had fallen below 6 percent at the end of February, but began to inch higher after the United States and Israel attacked Iran on Feb. 28. The war in Iran has driven up energy costs, which in turn has stoked inflation fears. In response, investors have pushed up the yield on the 10-year Treasury note, which influences mortgage rates.
Adjustable-rate mortgages can be significantly lower than their fixed-rate counterparts, real estate experts say, sometimes as much as a full percentage point, a difference that can potentially save home buyers thousands of dollars annually. The ARM, as the loan is known, also comes with the risk that rates will continue to climb, hurting owners when the loan resets.
Despite the possible pitfalls, ARMs are an increasingly enticing option among buyers put off by the jump in fixed-rate mortgages, said Joel Kan, deputy chief economist at the Mortgage Bankers Association, a trade group. “They are looking for more ways to get into that home,” he said.
The association reported a recent uptick in the share of ARM applications, to 10.3 percent of overall mortgage applications, the highest in a year.
Here’s what you need to know about adjustable-rate mortgages.
How does an adjustable-rate mortgage work?
Fixed-rate mortgages lock in one rate over the lifetime of the loan, usually 30 years. ARMs, on the other hand, offer a low “teaser” rate for a set time, typically five, seven or 10 years, after which they readjust to the market rate, often annually, for the remainder of the loan. This helps owners keep their monthly payments lower during the introductory period.
Borrowers who use ARMs are betting that mortgage rates will eventually fall, giving them the opportunity to refinance their loan at a lower rate or sell their home before the introductory period ends and the rate begins to fluctuate.
ARMs make up a small portion of the overall mortgage market, which is dominated by fixed-rate products. But now that fixed-rate mortgages have climbed above 7 percent, interest in ARMs is starting to grow, said Archana Pradhan, the principal economist at Cotality, a provider of housing market data.
Lenders discount the ARM introductory rate because they will make more profit once the variable rate kicks in. The national average rate for an ARM with a five-year introductory rate that resets annually is 6.56 percent, according to Bankrate.com.
“The wider the gap between ARM rates and the fixed rates, the stronger the incentive to choose an ARM,” Ms. Pradhan said.
How safe is an ARM?
ARMs offer savings for borrowers, but they also introduce market volatility.
The loans were popular during the early 2000s housing bubble, peaking at around 36 percent of overall mortgage applications in 2005, according to data from the Mortgage Bankers Association. After the housing market crashed in 2008, the share of applications for ARMs plunged to about 6 percent.
Stricter underwriting standards have made ARMs safer for consumers, who are protected by regulatory limits that prevent the variable rate from jumping too high.
Still, they are not for everyone, said Nick Rocco, a mortgage loan officer in the Baltimore area. Borrowers need to have a plan for what to do after the introductory period ends regardless of where mortgage rates are. “There is no crystal ball,” he said.
Who should apply for an ARM?
Nearly 72 percent of home buyers who take out an ARM have a chance within five years to refinance it into a 30-year fixed-rate mortgage that is at least 0.5 percentage points lower than their original rate, according to a report from Redfin, an online real estate marketplace.
That can translate into big savings every month for some borrowers, Ms. Pradhan said. “It’s more meaningful for higher loans, because they are able to save hundreds of dollars compared to the lower amount of loans,” she said.
Mr. Rocco said he recently worked with a couple who used an ARM to finance the purchase of a $750,000 home. The buyers had experience with ARMs, he said, and knew to put 20 percent down, which lowered their introductory rate.
“They have a little more risk tolerance and they’re a little bit more comfortable knowing the fact that they can refinance out of that adjustable rate,” he said.
But Ms. Pradhan said ARMs made better sense for buyers who intended to sell after the introductory period ended. “You are not intending to live in the house forever,” she said.
“Refinancing may be an exit strategy, but it’s not a guarantee,” she added. “One of the risks of an ARM is the higher payment in the future.”
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