They are no longer taboo…
To some whose memories of the Great Recession 15 years ago remain vivid, the term “adjustable-rate mortgages” is akin to pejorative. But one mortgage industry veteran is touting ARMs over their fixed-rate counterparts as a smoother pathway to homeownership in a time of rising rates, inflation and soaring property values.
First, some historical context: The housing that began late 2007 was exacerbated by the abundance of homeowners with adjustable-rate mortgages. As these ARMs adjusted against a backdrop of subprime, mortgages legions were unable to afford their payments and forced to abandon their homes.
But that was then and this is now, suggested Melissa Cohn (pictured), regional vice president at William Raveis Mortgage and a 40-year mortgage industry veteran.
“That’s like talking about the Old World,” she said in an interview with Mortgage Professional America. “Adjustable-rates are a very different animal today. The adjustable-rate mortgages that gave ARMs a bad name and reputation were loans with which monthly payments were not sufficient even to cover the interest that was due on the mortgage and the loan negatively amortized, meaning that each payment you made was only a partial payment of the interest due. Instead of paying down your mortgage, the principal balance grew each month. Those mortgages don’t exist today, except in very rare exceptions.”
Today’s version is decidedly different, she added. “Adjustable-rate mortgages today are loans that amortize,” she said. “They walk, talk and act like a fixed rate for the initial rate period.”
Today’s ARMs offer flexibility too, she noted: “You can get an adjustable-rate for three years, five years, seven, up to 15 years. Let’s say there’s a seven-year adjustable: During the first seven years, it’s a fixed rate as far as you know. The monthly payment is interest and principle; you’re paying down your loan the same way; you’re amortizing it the same way you would with a 30-year fixed. At the end of the initial rate period, there are adjustments. You’re never negatively amortizing the loan. There are caps, formulas that determine what the rate will be using well known, easily found indices such as the 10-year Treasury or the new SOFR Index. They act as a great bridge.”
With rates rising, buyers are looking to save money. Glancing at current rates – fixed versus adjustable – that tactic would yield benefits, adding to ARMs appeal. As of mid-June, the average rate of a 30-year fixed-rate mortgage is 5.23% -- more than twice what it was a year ago. An ARM, meanwhile, is averaging only 4.12%.
Even a 1% difference in mortgage rates amounts to real money, she noted. On a $500,000 loan, a full percentage point difference means $5,000 – 1% of the loan amount – saved, equal to $400 a month. “That’s a lot of money,” she said.
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Such cost savings have resulted in a growing interest for ARMs. According to data from the Mortgage Bankers Association, applications for ARMs rose to a 14-year high at the beginning of May.
Cohn was touting ARMs even during the peak of the pandemic, she said, when they were floating in the 2% range amid a period of historically low rates. “They’re a great opportunity to take us through this period of hyperinflation and high mortgage rates,” she said. “The average of a 3%,” she said during the June 15 interview with MPA, “It reached 6% yesterday, where adjustable-rates can still be found in the low to mid 4s.”
Another advantage is that consumers aren’t locked into a rate for an undetermined amount of time. “You can repay and refinance anytime,” she said. “There’s nothing to hold you back from refinancing when you find the right rate opportunity.”
Still, she’s not suggesting the strategy as a long-term one, she said. “I’m not suggesting adjustable-rates are a long-term solution. I consider them to be a good bridge right now.” First-time homeowners looking for “a starter home, not a forever home” represent ideal ARM dealers, as do homeowners who don’t plan to live in their homes for the full 30 years of their fixed term, she noted.
In these volatile times and while the Fed is continually adjusting rates in efforts to tame inflation, ARMs may be something to consider.