(6 Minute Read) – Adjustable Rate Mortgages are making a comeback.
With the average selling price of a home in Portland at $565,000, many would-be homebuyers are struggling to make their dream of homeownership come true. Add to that low inventory and rising mortgage rates, and many are left wondering whether they’ll be able to land a place to call home.
Mortgage rates are rising as the Federal Reserve works to lower inflation by raising short-term interest rates. Those increases ultimately make it more expensive to borrow money. Rates on a 30-year fixed mortgage are the highest they’ve been since 2009, right after the housing market crash of 2008. Record-low interest rates over the past few years have led to increased demand for home loans and higher prices for the homes available for purchase.
“ARMs allow members to qualify for more home than a fixed rate.”Amy Olson, AVP of Residential Mortgage Lending, Unitus Mortgage
There are some alternatives to the increasing rates on traditional 30-year fixed mortgages. Adjustable Rate Mortgages (ARMs) are becoming increasingly popular. They offer a lower fixed rate at the beginning of the mortgage, making monthly payments lower.
In fact, most ARMs allow members to qualify at a lower start rate than fixed products, which gives them an advantage over other buyers,” explained Amy Olson, AVP of Residential Mortgage Lending at Unitus Mortgage. “Members using an ARM product can purchase up to $40,000 more in purchase price and have the same house payment as a member with a fixed product. This is a tremendous help when members get into bidding wars, which is common in today’s real estate market with limited housing inventory.”
How Have Adjustable Rate Mortgages Changed?
While the ARMs of the early 2000s played a role in the collapse of the housing market in 2008, new rules and protections make them more secure than they were back then. There are now limits on how much a mortgage rate can adjust, along with caps put in place to prevent the mortgage rate, and therefore the monthly payment, from rising too fast. Most lenders now qualify borrowers on whether they can afford future payments after the rate adjusts as opposed to the initial lower payments.
Another improvement in ARMs is more stability in the index now used to determine rates. The industry standard is now the Secured Overnight Financing Rate (SOFR). ARMs of the past typically used the London Interbank Offered Rate (LIBOR). The difference in these indexes is that SOFR is based on actual transactions and LIBOR is based on estimated borrowing rates. SOFR is considerably less volatile than LIBOR, which means it increases slowly. From September 2014 to early 2020, the SOFR index averaged about 0.73 percentage points. The adjustable rate you pay once the fixed term expires is determined by adding the SOFR index to the lender’s margin.
How do ARMs Work?
Now that you understand why ARMs are a safer loan than they were 15 years ago, you may be wondering exactly how an ARM works.
Adjustable Rate Mortgages always start out fixed and adjust after the fixed period expires. Unitus Mortgage offers a 10/6, 7/6, 5/6, and 3/6 ARM. The first number is the number of years the rate is fixed and the second number is how often it adjusts. For example, a 10/6 ARM means the lower fixed rate is locked in place for 10 years and adjusts every six months after that. In the 121st month (the first month after the 10-year fixed period), the rate adjusts and will continue to adjust every six months for the life of the loan. However, there are now protections in place to ensure the rate doesn’t increase too much too fast.
How is the Rate Adjusted?
After the initial fixed-rate period, the ARM adjusts to the “fully-indexed” rate. You pay this rate on the remaining balance of your mortgage. The rate is determined by adding the lender’s margin (Unitus Mortgage’s set margin is 2.75%) and the SOFR index rate (currently at 0.286% on May 20, 2022). The fully indexed rate for this six month period would be 3.036% in this example. At month 127, the rate would adjust again using this same formula. While homebuyers should be aware the rate could increase during the adjustment period, in today’s market, the rate would actually decrease, meaning a lower monthly payment for those six months.
There are “caps” and “floors” on how high or how low the rate can adjust. Caps limit the amount the interest rate can increase. In ARMs, there is usually a cap that applies to the first adjustment after your fixed rate ends. There are other caps that apply for each adjustment period and a “lifetime cap.” Lifetime caps can be a specific interest rate, for example 7.5%—meaning your rate cannot exceed 7.5% at any point during the loan. Lifetime caps can also be defined as a certain percentage rate over your initial rate. For example, a lifetime cap of 5% over your start rate would mean that your rate will never exceed your starting rate plus 5%.
Floors are just the opposite, meaning they are the rates that your loan cannot fall below. In the past few years, some indexes have dropped to the point that mortgage lenders wouldn’t be able to cover their costs because rates would have decreased too much. A floor protects the lender’s operating costs. If your loan has a floor of 2.0%, your rate will never drop below this, even if the fully-indexed rate is lower.
Why Consider an ARM?
Adjustable Rate Mortgages are not for everyone, but they do provide some flexibility for homebuyers who want more purchasing power and lower monthly payments. ARMs can save you money on your monthly payments during the fixed rate period when compared to higher 30-year fixed rates. They may also make sense for a homebuyer who plans to move or refinance before the fixed rate term expires. At the end of the day, choosing the right mortgage is a very personal decision—one best made with the expertise of a qualified lender. Unitus Mortgage is currently offering some of the lowest ARM rates in the Pacific Northwest.
“We know how challenging it can be to navigate a mortgage, whether it’s your first time or your tenth,” said Olson. “We have the experience, the expertise, and the motivation to get our members the right loan for their individual situation. We don’t look at lending with a one-size-fits-all approach.”
You can learn more about ARMs and even use our mortgage calculators to compare rates online. You can also check out our offers for first-time homebuyers. Some homebuyers can qualify for zero-down loans and even earn cash back at the close of the loan. Contact Unitus Mortgage today to learn about the right loan to help you find your next home.