NerdWallet: ARMs are making a comeback—are they too risky for hopeful homebuyers?

by | Jul 5, 2022 | Stock Market

This article is reprinted by permission from NerdWallet.  Adjustable-rate mortgages suffered a tarnished reputation after the 2008 financial crisis. They faded away and lurked on the fringes of the mortgage market for years. But as home buyers grapple today with skyrocketing prices and interest rates, ARMs are making a comeback. And that’s totally not a bad thing.

ARMs are appealing because they start out with lower interest rates than their fixed-rate counterparts. For some borrowers, ARMs make it possible to buy a home even after fixed-rate mortgages have risen past the point of affordability. ARMs are appropriate for some buyers and carry too much risk for others, and the line between those judgments can be fuzzy. It’s important to understand what’s really behind this year’s surge and how to decide whether an adjustable rate would be right for you. Check out: The cities where housing costs are poised to drop, according to one expertARMs gain share In early January, adjustable-rate mortgages accounted for 3.1% of home loan applications, according to the Mortgage Bankers Association. Four months later, ARMs accounted for 10.8% of mortgage applications. Why did demand for ARMs more than triple in just four months? Because fixed mortgage rates soared:
In Freddie Mac’s weekly rate survey, the 30-year fixed-rate mortgage averaged 3.22% in the first week of 2022, and shot up to 5.3% in mid-May.

While the 30-year fixed was going up more than 2 percentage points, the average rate on the 5-year ARM was rising less than 1.6 percentage points: from 2.41% to 3.98%.

Rising mortgage rates eroded home buyers’ borrowing capacity. If you can afford $1,500 a month in principal and interest, you can borrow $344,700 with a 30-year fixed-rate mortgage at 3.25%. But at 5.25%, you can afford to borrow about $271,600 — or $73,100 less. Some home buyers didn’t revise their price ranges downward as rates climbed. After months of house-hunting, they had offers accepted, only to discover that they couldn’t afford the monthly payments using 30-year fixed-rate mortgages. They turned to lower-rate ARMs to salvage their home purchases. “Borrowers are switching to ARMs for a lower mortgage rate to t …

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