Adjustable rate mortgages (ARMs) dropped out of favor in the aftermath of the housing crisis. The loans, with their changing interest rates, were among multiple factors blamed for the wave of homeowners losing their properties to foreclosure when they couldn’t make their payments.
Now ARMs are making a comeback. In December 2018, 9.2 percent of all new mortgage loans had an adjustable rate, up from 8.9 percent in November and a far above the 5.6 percent of mortgages that were ARMs in December 2017, according to the Origination Insight Report from Ellie Mae, a software company that processes 35 percent of all mortgages in the United States. The number of ARMs in December 2018 was the highest share recorded since Ellie Mae began tracking loans in 2011.
When mortgage rates rise, ARMs become more popular with buyers who want to keep their payments lower during the early years of the loan. Today’s ARMs are typically hybrid ARMs, which have a fixed interest rate for a period of five, seven or 10 years, followed by an annually adjusted mortgage rate for the rest of the 30-year loan term. The amount the loan can adjust is capped for the first adjustment, subsequent adjustments and an overall maximum adjustment.
Today’s ARMs are typically hybrid ARMs, which are 30-year loans with a fixed interest rate for a period of five, seven or 10 years, followed by an annually adjusted mortgage rate for the rest of the loan term. The amount the loan can adjust is capped for the first adjustment, subsequent adjustments and an overall maximum adjustment. ARMs are identified as 5/1, 7/1 or 10/1 to designate the initial fixed period and how often the loan adjusts after the fixed period.
For example, in a recent comparison of mortgage rates, which shows the rate for the initial fixed period, a 5/1 ARM was 3.5 percent, a 7/1 ARM was 3.75 percent and a 10/1 ARM was 4.0 percent, while a 30-year fixed-rate loan was 4.125 percent.
The 5/1 ARM included typical caps of 2 percent on the first and subsequent adjustments and a lifetime cap of 6 percent. That means the mortgage rate could adjust only to 5.5 percent in the sixth year of the loan and to a maximum of 9.5 percent in the future.
Borrowers must qualify for these loans based on estimated payments for future adjusted rates.
If you’re considering an ARM, be certain you have a plan for the worst-case scenario in the event your mortgage rate reaches the highest possible amount. Homeowners who plan to sell before their loan adjusts or who have confidence that their income will rise sufficiently to afford potentially higher payments make the best candidates for ARMs.
Financial experts don’t recommend them for people who are having trouble qualifying for a loan since this could put them in a risky position in the future.