3 June 2020

With Rising Interest Rates, Adjustable Rate Mortgages Find Traction

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With rising interest rates, adjustable-rate mortgages (ARMs) are starting to gain steam in the real estate market.

ARMs are slowly growing in popularity as interest rates continue to climb. While they are not being used as much as in the past, their share has grown by half since May. ARMs fell off the map while interest rates fell to historic lows and were widely accused of causing defaults once the introductory rates jumped after the initial lock-in period.

With recent news that the Federal Reserve is considering a slowing of the bond-purchase program, rates for 10-year U.S. treasuries have climbed more than a percentage point between early May and July. Fixed-rate mortgages, which follow 10-year Treasuries, rose to 4.51% last month from 3.34% in January.

ARMs follow short-term rates like one-year Treasuries. Because the Fed will keep short-term rates very low until unemployment is 7.0% or lower, one-year Treasuries traded at a 0.1% yield on Wednesday, down 0.04% in the last month. Because of this, fixed-mortgage rates have risen twice as fast as five-year ARMs.

According to data from the Mortgage Bankers Association of America, last week, 6 percent of mortgage applications were for ARMs, up from only 4 percent in May. The ability to secure an ARM has helped keep homes affordable and has also kept buyer interest high despite the rise in fixed-rate mortgages.

A major drawback to the ARM is based on the “adjustable” component. Interest rates can rise after one, five, seven or 10 years, with the first jump potentially between 2 and 5 percentage points. Because of this, they are generally best suited for buyers who plan to sell or refinance before the interest rate changes.
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