More Buyers Consider Variable Rate Mortgages as Interest Rates Rise | Nation
Homebuyers have had to accept that mortgage rates are unlikely to fall back to record lows anytime soon.
The average 30-year fixed rate was 5.3% as of Thursday, according to government-backed mortgage buyer Freddie Mac. That’s up from 2.8% a year ago.
Due to higher mortgage rates and ever-rising home prices, fewer aspiring buyers can afford to buy homes. “We’re seeing people getting a little desperate,” said Jacob Channel, senior economist at the online lending marketplace LendingTree.
Enter the variable rate mortgage. During the first half of 2022, as interest rates rose, the share of adjustable-rate mortgages nationwide rose from 3% to 10% of loans, according to the Mortgage Bankers Association.
These loans start at “teaser” interest rates that are generally lower than fixed rate loans. After a certain number of years, the rate adjusts periodically according to economic conditions.
“People always ask about them when interest rates go up,” said Phil Giordano, director of Republic Bank’s residential mortgages division, “but very few in the long run choose to take them.”
He said that over the past 90 days he has seen the number of adjustable rate loans in the bank’s pipeline increase by about 5%. Republic lends in the tri-state area and New York.
Mortgage rates are still at historic lows from the double-digit rates of the 1980s, and fixed-rate mortgages remain the most popular choice among homebuyers. The 30-year fixed rate is down from around 5.8% in June.
Why do buyers choose an adjustable rate mortgage?
The average interest rate for a mortgage in which the rate stays the same for five years and then adjusts annually — a common deal called a 5/1 ARM — was 4.29% on Thursday, according to Freddie Mac. This is higher than a year ago, but about a percentage point lower than the 30-year fixed rate.
“It really makes sense that some people are turning to ARMs instead,” said Erika Giovanetti, loan expert at US News & World Report.
A percentage point might not seem like a big difference, but homeowners could potentially save hundreds of dollars on their monthly payments.
Many borrowers use adjustable rate mortgages “much like a temporary tool,” Giovanetti said. They consider that if they sell their house or refinance their loan within the period when their interest rate is fixed, they will not have to deal with unknown rates.
If owners have plenty of money or anticipate higher income, they may not be as concerned about the possibility of higher interest payments in the future. And adjustment caps determine how much the interest rate can change.
Why is a resurgence of MRAs making some people nervous?
When Giovanetti first heard that adjustable rate mortgages were becoming more popular, she said, “it took me back to the housing game of the early 2000s.”
“At first I felt quite worried, it was a bad sign of things to come,” she said.
In the years leading up to the Great Recession, about a third of all mortgages were variable rate. Borrowers who could not qualify for other types of loans took out mortgages at attractive interest rates that then ballooned to unaffordable levels. Foreclosures and the collapse of the housing market followed.
But Giovanetti’s second thought was that the market is in a very different place than it was then. The loan servicing industry is more regulated and lenders are more concerned with ensuring that borrowers can afford loans.
“Even if you get an adjustable rate mortgage today, you’re probably in a better position to handle it than someone was 15 years ago,” Channel said. “It finally shows that there is not so much reason to worry that it will lead to another accident.”
And even with the growth of variable rate mortgages, they still only represent about 10% of all mortgages.
What should owners keep in mind?
“The whole ‘adjustable’ part of adjustable rate mortgages is something you have to be careful about,” Channel said. For many people, “their best bet will always be a fixed rate mortgage. Because it brings a sense of security.
The main concern is that homeowners may no longer be able to pay once their mortgage rates are adjusted. Because even if the rates could adjust downwards, the lenders are betting on a rise in the rates. Homeowners could end up spending more monthly and over the life of the mortgage than they would with a fixed rate loan.
“You really take a lot more risk,” Giovanetti said. Borrowers “must understand what they are getting into”.
Figuring out the costs and which of the many types of adjustable loan terms will work best “is kind of a complicated endeavor,” she said.
Whether these mortgages might be a good idea depends on how much value borrowers can get from the lower initial rate. The number of years the interest rate stays fixed varies by loan type. When the fixed rate ends, some loans adjust every six months, while others adjust annually.
Life circumstances can derail initial plans to sell before the mortgage rate adjusts. If homeowners choose adjustable rate loans with the intention of refinancing later, they should consider closing costs, which are typically 2-5% of the total loan amount.
Buyers should consider their personal circumstances. For example, a borrower’s credit history helps determine interest rates.
Homebuyers should talk to mortgage lenders and even a financial adviser about their options, Giovanetti said, and review loan estimates from various products. Government-backed loans, for example, often offer lower fixed rates than their conventional counterparts.
Ultimately, the difference in how much a buyer will pay in interest for fixed-rate loans versus adjustable-rate loans shouldn’t be the deciding factor in determining whether a home is affordable, Giordano said. And “if so, you probably can’t even afford [the loan] at the adjustable rate,” he said, and should look to lower-priced homes.