Some borrowers give adjustable-rate mortgages a second look as fixed rates top 7%

Redfin analysis finds ARM holders had a lower-rate opening about 70% of the time

With the rate on a 30-year fixed mortgage at 7% or more, some American homebuyers are reconsidering the adjustable-rate mortgage, a loan type many still associate with the housing crash. NPR reported the reconsideration on Nov. 5, and FRED, the Federal Reserve Economic Data database, put the average 30-year fixed rate at 7.18% as of that date.

The stakes run beyond one loan product. The 30-year fixed-rate mortgage reigns as the most popular kind of home loan in the United States, and the country is the only one where that is true, according to NPR’s reporting. Adjustable-rate mortgages make up only about 5% of U.S. mortgages. Wailin Wong and Adrian Ma of The Indicator from Planet Money, an NPR program, examined why borrowers are taking a second look and what the historical record shows.

An adjustable-rate mortgage, or ARM, starts with an introductory teaser rate that usually runs a little below the prevailing fixed rate. After a set period, the interest rate resets to wherever the market stands. Rates can also reset lower, Wong noted, and in recent history that is what they have done.

The loans carry heavy memories from the housing bubble. ARMs accounted for about a third of all mortgages originated during the run-up to the crisis. In the early 2000s, predatory lenders pushed novel kinds of ARMs on people with low incomes and bad credit, and loose underwriting standards meant borrowers won approval based solely on whether they could afford the low teaser rate. At the peak of the subprime crisis, the delinquency rate for conventional ARMs ran at double that of fixed-rate mortgages, according to an analysis from Duke cited in the segment.

Regulators added safeguards after the financial meltdown. Borrowers today must qualify for a rate well above the teaser rate. Still, ARMs carry stigma, and Chen Zhao, head of economics for Rocket Mortgage and Redfin, said the fear points one way. “A lot of times when people are thinking about, oh, the rate might adjust, you naturally go to this place where, oh, the rate might adjust upward, and that is kind of scary, right?” Zhao said.

Zhao and her colleagues at Redfin recently analyzed mortgage rate data going back to 1971. Year by year, they asked one question: “If you had chosen an ARM versus the 30-year fixed, would you have had an opportunity to refinance your ARM into a lower rate?” About 70% of the time, people with adjustable-rate mortgages had at least one shot at getting a lower rate.

“What this is telling you is that over this, like, long stretch of time, for the most part, ARMs made sense,” Zhao said. People with fixed-rate mortgages could also have refinanced at lower rates, the segment noted, but that process comes with additional costs.

The findings carry two big caveats, Ma said. First, the 40-year period in which rates got low could have been a historical anomaly. Second, borrowers are human beings: it is one thing to read a spreadsheet showing ARMs were historically the more cost-effective option, and another to sign a loan contract. “It’s not just about the numbers and the black and the white. It’s a lot about emotions too,” Zhao said.

For most homeowners, the certainty of knowing exactly what the monthly payment will be is worth paying a little extra for, Ma reported. ARMs do have their appeal, Wong concluded. It is just not broad.