Last year, Jennifer Hernandez was shocked to receive notice that her Houston home mortgage payments would jump by about $2,000 per month. She had refinanced her home loan in 2016 using an adjustable-rate mortgage loan, which initially had a low introductory rate for a fixed period. As many homeowners like Hernandez are now experiencing, adjustable-rate mortgages (ARMs) can offer temporary relief from higher mortgage rates, but also come with the risk of rates adjusting periodically based on market conditions.
For thousands of Americans who took out ARM loans five years ago, before interest rates rose to a four-decade high, the time has come for their rates to reset. This is happening amidst an unaffordable housing market, with mortgage rates remaining elevated. According to data from Intercontinental Exchange, 1.7 million homeowners have bought homes with adjustable-rate mortgages since 2019. Many buyers who opted for 5-year ARMs will now face significantly higher monthly payments this year.
Despite gaining a bad reputation after the subprime mortgage crisis of 2007 and 2008, ARMs have doubled in popularity over the past four years, according to the Mortgage Bankers Association. Loan consultant Lorraine Jones explained that ARMs may be suitable for homebuyers who are comfortable with the risk of interest rate increases or plan to move or refinance before the fixed rate expires.
However, it is crucial to pay close attention to the details of an ARM loan. Hernandez, who is a loan officer herself, realized that she had misremembered the terms of her $1.1 million loan. Instead of a 10/1 ARM, she had taken out a 7/1 loan. Her mortgage rate jumped by 2% to 5.125% last October, the maximum allowed in the first adjustment year according to her loan terms. Hernandez now faces the challenge of adjusting to higher monthly payments, with her ARM capped at 8.125%.
Despite the current stress, some homeowners like Andrew Marquis, a loan officer in Massachusetts, have seen a dramatic increase in ARM loan applications. Marquis suggested that buyers believe the Federal Reserve may cut interest rates in the next few years, giving them time to refinance before the fixed period of their ARM ends. The Federal Reserve’s actions influence mortgage rates, and this year, the Fed has hinted at a possible rate cut.
Marquis noted that taking out an ARM loan could be beneficial for those with a higher risk appetite. He mentioned that about 40% of jumbo loans he is working on are ARMs, with borrowers potentially saving hundreds of dollars a month. Interest rates may be unpredictable, but for homeowners like Hernandez, who saved money in the initial years of her loan, the increase in payments now feels challenging. She expressed her hope that by the time her October adjustment comes around, rates will have decreased slightly.
