Adjustable Rate Mortgages from 2019 to 2024: How They Work and Impact

Adjustable rate mortgages have been a staple in the US mortgage market since 2019. In 2019, the initial interest rate for a 5-year adjustable rate mortgage was around 3.8%.

Many homeowners opt for adjustable rate mortgages because they often offer lower interest rates than fixed-rate mortgages. This can lead to lower monthly payments.

The initial interest rate for a 7-year adjustable rate mortgage in 2019 was around 3.5%. This rate can change periodically based on market conditions.

Homeowners who choose adjustable rate mortgages should be aware that their monthly payments can increase or decrease over time.

On a similar theme: Mortgage Rates Two Year Low

Adjustable Rate Mortgages (ARMs) are a type of mortgage where the interest rate can change periodically based on market conditions. In 2023, the San Jose, California metro area had both the highest average sale price and the largest share of ARMs out of all conventional mortgage originations.

The most common ARMs today are of the 5/1 and 7/1 type, which minimizes the risk by limiting the number of years the rate can adjust. These types of ARMs have largely replaced the riskier products that were popular before the Great Recession.

In May 2024, among mortgage originations exceeding $1 million, ARMs comprised 40% of the dollar volume, unchanged from May 2023.

The main difference between traditional fixed-rate mortgages and adjustable-rate mortgages (ARMs) lies in how the interest rate is calculated. ARMs are based on a floating rate, which can change over time, whereas fixed-rate mortgages have a fixed interest rate that remains the same for the life of the loan.

The Alternative Reference Rate Committee (ARRC) has proposed changes to the way ARMs are calculated, shifting from a 1-year LIBOR to a 30- or 90-day average of the Secured Overnight Financing Rate (SOFR). This change aims to reduce the risk of payment shock that can occur when interest rates change rapidly.

The proposed changes also include computing interest in advance based on SOFR at the beginning of the interest period, rather than in arrears at the end of the period. This can help minimize the risk of payment shock, but it also requires adjusting the floating rate every six months, rather than once a year.

Consider reading: 10/1 Arm Mortgage Rates Today

Here's a summary of the proposed changes:

These changes aim to reduce the risk of payment shock and make ARMs more stable for homeowners. However, it's essential to understand that ARMs still carry risks, and homeowners should carefully review their loan terms and consider their financial situation before choosing an ARM.

Saving money with an Adjustable Rate Mortgage (ARM) is a real possibility, as one person has discovered by switching to a 7/1 ARM. They're paying 2.125% instead of 2.75% for a 30-year fixed mortgage.

This has resulted in significant savings, with almost $10,000 in interest expense saved every year. Over the seven-year fixed duration, they're likely to save ~$65,000 in gross mortgage interest expense.

ARM rate adjustments do have caps, though, which can provide a buffer against future rate increases. The cap is usually a 2% increase in the first year, and 1% a year after.

This means that even if mortgage rates stay high, the break-even period for the ARM won't start until the eleventh year, giving the homeowner a $65,000 buffer to fall back on.

The economic impact of adjustable rate mortgages (ARMs) has been significant over the past few years. The ARM share declined to a 10-year low of 4% of mortgage originations in January 2021.

As interest rates rose, ARMs gained renewed traction and the ARM share rose to 15.5% of the dollar volume of conventional single-family mortgage originations in May 2024. This is the highest level of the year so far.

The average 30-year, fixed-rate mortgage (FRM) interest rate increased to 7.06% in May from 6.99% in April, making ARMs more attractive to homebuyers. The spread between the FRM interest rate and the ARM interest rate narrowed during the pandemic and is now at the pre-pandemic level.

Homebuyers can save a significant amount of money in the initial payment with ARMs, especially for bigger loans. The ARM share varies significantly based on location and loan amount, with ARMs being more common in expensive areas and among homebuyers borrowing large loans.

As we explore the world of adjustable rate mortgages, let's take a closer look at the data. In 2023, the San Jose, California metro area had both the highest average sale price and the largest share of ARMs out of all conventional mortgage originations.

ARMs are more common in areas with higher average sales prices, like San Jose.

According to CoreLogic, as of April 2024, ARMs accounted for approximately 5% of conventional originations by dollar amount and 3% by count. This is a relatively low percentage, considering the rising popularity of ARMs in recent years.

The most common ARMs today are of the 5/1 and 7/1 type, which minimizes the risk. Since 2010, the riskiest ARM products have largely vanished, thanks to regulations like the Ability-to-Repay and Qualified Mortgage standards.

Here's a breakdown of the ARM share by mortgage amount in May 2024:

Note how the ARM share decreases as the mortgage amount decreases. This suggests that ARMs are more popular among high-end homebuyers.

Higher mortgage rates can be a good thing, especially for borrowers who plan to sell or refinance their homes within a few years. This is because the interest rates on adjustable rate mortgages can be capped, providing a sense of security for homeowners.

By 2020, the average 5/1 adjustable rate mortgage had a starting interest rate of 3.5%, which is significantly lower than the average 30-year fixed mortgage rate. This makes adjustable rate mortgages a more attractive option for some borrowers.

Many homeowners are not stuck with higher mortgage rates forever. In fact, by 2022, 75% of adjustable rate mortgages had a cap on their maximum interest rate, preventing borrowers from being hit with extremely high rates.

Having a cap on interest rates can provide a sense of security for homeowners, especially those who are on a tight budget. By knowing that their interest rate can't go above a certain level, borrowers can budget more effectively and make long-term plans.

For example, by 2024, the average 5/1 adjustable rate mortgage had a maximum interest rate cap of 10%, which means that even if the market interest rates rise significantly, the borrower's rate can't go above 10%.

Worth a look: 20 Year Mortgage Rates History