Navigating the Surge in Adjustable-Rate Mortgages: What Homeowners Need to Know

Jennifer Hernandez was shocked last year when she received notice that her mortgage payments on her Houston home would increase by about $2,000 per month. This unexpected hike was due to her decision in 2016 to refinance with an adjustable-rate mortgage (ARM), which offered a low introductory rate for a fixed initial period.

Adjustable-rate mortgages (ARMs) are loans with interest rates that change over the life of the mortgage, meaning monthly payments can go up or down over time, according to Freddie Mac. Unlike fixed-rate mortgage loans, ARMs provide temporary relief from higher mortgage rates but come with significant risk. After the initial fixed period—typically five, seven, or ten years—the rate on an ARM adjusts periodically based on current market conditions.

The Growing Popularity and Risks of ARMs

Data from Intercontinental Exchange (ICE), a global provider of technology and data, shows that 1.7 million homeowners have purchased homes with ARMs since 2019. Many of these buyers, especially those with five-year ARMs, are now facing significantly higher monthly payments as their fixed periods reset in 2024.

The financial data organization Bloomberg reported that approximately 70% of ARM holders are concerned about making their new monthly mortgage payments given rising interest rates. Meanwhile, one in ten respondents admitted they might delay or default on their mortgage once it adjusts. Adjustable-rate mortgages for five years are now around 6.5%, nearly double the rate from several years ago, according to Bankrate. This means homeowners with new ARM loans could see their payments increase by $1,000 or more each month.

The Reality of Rising Mortgage Rates

Jennifer Hernandez’s experience is not unique. Most homeowners in the U.S. who took out adjustable-rate mortgages are likely to see a spike in their monthly payments soon. Mortgage rates have remained elevated, contributing to one of the most unaffordable housing markets in decades. Rates on 30-year mortgages average 7% in 2024 amid high inflation, according to Freddie Mac.

Hernandez, a loan officer herself, misremembered the terms of her $1.1 million loan, thinking she had a 10/1 ARM when she actually had a 7/1 ARM. “I just got caught blindsided,” she said. Last October, her mortgage rate jumped by 2% to 5.125%, the maximum allowed in the first adjustment year. Most ARM loans come with an interest rate cap to prevent costs from spiraling out of control, but even so, Hernandez anticipates her payments will increase again this October.

Weighing the Benefits and Drawbacks

An ARM can be a viable option for homebuyers who are comfortable with the risk of interest rate increases or who plan to move or refinance before the fixed rate expires. However, it’s crucial to pay close attention to the loan details. Andrew Marquis, a loan officer in Lexington, Massachusetts, has seen a dramatic increase in ARM loan applications recently. Many homebuyers believe the Federal Reserve will cut interest rates in the next few years, giving them time to refinance before their ARM’s fixed period ends. “If people can save a half a percent on a seven-year ARM versus a 30-year fixed, they’re saving hundreds of dollars a month,” Marquis explained.

Conclusion: Proceed with Caution

Interest rates can be unpredictable, and while some homeowners like Hernandez saved money in the initial years of their loan, the eventual rate adjustments can be financially challenging. Bloomberg’s recent poll noted that higher mortgage rates are creating challenges for homeowners who bought or refinanced their homes over two years ago, as they are reluctant to give up their fixed-rate mortgages below 3% or 4%.

For homeowners considering ARMs, it’s essential to understand the risks and be prepared for potential payment increases. As the market evolves, staying informed and planning ahead can help mitigate the financial impact of adjustable-rate mortgages.

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