The Rise of Adjustable-Rate Mortgages in a High-Rate Environment

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What Is an Adjustable-Rate Mortgage, or ARM?

Adjustable-rate mortgages (ARMs) are a type of conventional mortgage where borrowers pay a fixed rate for a set number of years, followed by a variable rate for the remaining term. The most common ARM is the 5/1 ARM, which features a fixed interest rate for the first five years of a 30-year mortgage, then adjusts annually based on market rates.

How Does an Adjustable-Rate Mortgage Work?

In a 5/1 ARM, the initial five-year period has a fixed rate, typically lower than a comparable fixed-rate mortgage. After this period, the rate adjusts annually based on a market index plus a margin. For example, in May 2023, many 5/1 ARMs had a variable rate of 4.75% plus a 2.75% margin, totaling 7.50% APR. Monthly payments are recalculated annually based on this formula, with caps limiting how much the rate can increase.

ARMs Get More Popular When Rates Are Higher

For current homeowners with fixed-rate mortgages, refinancing to an ARM may not be beneficial. However, for new homebuyers facing high home prices and interest rates, ARMs can offer lower initial monthly payments. In the early 2000s, ARMs made up nearly half of all mortgages, but their popularity declined after the 2008 recession. Recently, as interest rates have risen, ARMs have regained attention, comprising 8% of new mortgages as of April 2023.

Are ARMs a Good Decision?

Whether an ARM is a good choice depends on the borrower’s situation. Homeowners who plan to move before the fixed-rate period ends or expect their income to increase may benefit from the lower initial payments. However, approval for an ARM still requires demonstrating the ability to manage credit and monthly expenses.

ARMs Are Changing, but Payments Will Remain Nearly the Same

In 2023, the variable-rate portions of ARMs are transitioning to the Secured Overnight Financing Rate (SOFR) from a similar metric. Despite this change, the new SOFR is nearly identical to the previous rate, so borrowers will see little difference in their payments. The SOFR closely tracks the federal funds target rate, used by the Federal Reserve to manage inflation and borrowing costs.

At O1ne Mortgage, we understand the complexities of choosing the right mortgage. If you’re considering an ARM or any other mortgage option, call us at 213-732-3074. Our expert team is here to help you navigate your mortgage needs and find the best solution for your financial situation.

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