Why Is the Market Share of Adjustable-Rate Mortgages So Low? (2024)

FAQs

Why Is the Market Share of Adjustable-Rate Mortgages So Low? ›

Using a simple econometric model, we find that the low ARM share is largely consistent with long-run historical patterns in household mortgage choice—namely, that households tend to prefer fixed-rate mortgages when long-term interest rates are low relative to recent short-term rates.

One of the biggest risks ARM borrowers face when their loan adjusts is payment shock when the monthly mortgage payment rises substantially because of the rate adjustment.

One of the significant drawbacks of adjustable-rate mortgages is the potential for the monthly mortgage payment to increase. As the interest rate adjusts, the monthly payment changes accordingly.

The fall and rise of ARMs

For example, CoreLogic¹ data shows only 6% of mortgage applications for 30-year loans were for an ARM in January 2021, when rates were at historic lows. ARMs' popularity rose to 25% in November 2022, as the average fixed mortgage rate hit 6.8%.

This means the rate is free to adjust annually after being fixed for the first five years. While our numbers are based on the 2019 SCF, this Wall Street Journal article reported that ARM applications were just over 7% of all mortgage applications in 2023.

“Your mortgage is adjusted based on an index, and a spread over the index.” According to Ramsey, if you were to purchase a home today with an ARM, you would be paying a higher interest rate based on the index.

Compared to the standard 30-year and 15-year fixed-rate mortgages, 7/1 ARMs traditionally have lower interest rates, at least within the first seven months of the loan term. That low initial interest rate can make the 7/1 ARM an affordable mortgage option for homebuyers.

The most risky and predatory adjustable-rate mortgages — such as loans with below-market “teaser rates” that were designed to rise sharply, have also been eliminated.

An ARM may make good financial sense if you only plan to live in your house for that amount of time or plan to pay off your mortgage early, before interest rates can rise. An ARM may also make sense if you expect to make more income in the future.

ARMs generally come with lower closing costs when compared to other types of mortgages, which could result in significant savings upfront.

Why aren't arm rates lower? ›

Today, ARMs generally don't start floating for at least five years. Lenders also don't have as much wiggle room to lower the initial rate. The lowest ARM rates are typically reserved for affluent buyers with strong credit, who sometimes take loans that don't get sold to Fannie Mae and Freddie Mac.

The vast majority of borrowers with option adjustable-rate mortgages appear to have exercised the option to make small “minimum” payments on their mortgages. By making payments less than the accrued interest due, these borrowers increased, rather than decreased, their mortgage balances over time.

Some ARMs may require you to pay fees or penalties if you refinance or pay off the ARM early, usually during the initial period (the first three to five years) of the loan. Prepayment penalties can total several thousand dollars. It's important to know about these potential extra fees before you take out an ARM.

You might have to pay a prepayment penalty if you sell or refinance. If you do decide to refinance your adjustable-rate mortgage to get a lower interest rate, you could be hit with a prepayment penalty, also known as an early payoff penalty.

If you move in several years, an ARM could save you money. You'd benefit from the low introductory fixed rate, then sell the home before the adjustable period starts. You plan to pay off the mortgage quickly. Say, for instance, you expect a financial windfall, such as an inheritance.

Under an adjustable rate mortgage, both lenders and borrowers bear interest rate risk.

The main difference between ARMs and fixed-rate mortgages is that ARMs have an interest rate and monthly payments that can go up and down over time, whereas fixed-rate mortgages have an interest rate that never changes, so the monthly principal-and-interest payments stay the same.

ARMs offers come with substantial risks, such as higher rates due to interest rate changes in the housing market. Your first adjustment might only raise your monthly mortgage payment a little bit. Subsequent adjustments can put pressure on your financial situation.

Factors to Consider: Interest Rates and Credit Score

When comparing adjustable rate mortgages and fixed rate mortgages, it's essential to consider how changes in interest rates could affect your monthly payment and long-term financial stability.