Adjustable-rate mortgages are again gaining in popularity despite practically vanishing during the housing bust. Since home prices and interest rates rose last year, more people have turned to adjustable mortgages to keep their monthly payments affordable, with such mortgages offering a lower initial rate. However, the rate can rise over time with market changes.
In November, 11.2% of homes bought with loans carried adjustable-rate mortgages. That’s double the rate of a year earlier. Adjustable-rate mortgages, which all but vanished during the housing bust. Home prices and interest rates rose last year, and adjustable mortgages can help keep the monthly payment affordable — at least temporarily. Such mortgages offer a lower initial rate, but that rate can rise over time with market changes.
“You saw a big swing in people taking adjustable versus fixed rates” when prices and rates shot up last year, said John Ciolino, a senior loan consultant with Luther Burbank Mortgage. With interest rates expected to rise this year, the proportion of ARMs could increase further. “Generally, as rates increase ARMs become more popular,” said Guy D. Cecala, publisher of Inside Mortgage Finance.
•Feature lower rates and payments early on in the loan term. Because lenders can use the lower payment when qualifying borrowers, people can buy larger homes than they otherwise could buy.
•Allow borrowers to take advantage of falling rates without refinancing. Instead of having to pay a whole new set of closing costs and fees, ARM borrowers just sit back and watch the rates — and their monthly payments — fall.
•Help borrowers save and invest more money. Someone who has a payment that’s $100 less with an ARM can save that money and earn more off it in a higher-yielding investment.
•Offer a cheap way for borrowers who don’t plan on living in one place for very long to buy a house.
•Rates and payments can rise significantly over the life of the loan. A 6 percent ARM can end up at 11 percent in just three years if rates rise sharply.
•The first adjustment can be a doozy because some annual caps don’t apply to the initial change. Someone with an annual cap of 2 percent and a lifetime cap of 6 percent could theoretically see the rate shoot from 6 percent to 12 percent a year& after closing if rates in the overall economy skyrocket.
•ARMs are difficult to understand. Lenders have much more flexibility when determining margins, caps, adjustment indexes and other things, so unsophisticated borrowers can easily get confused or trapped by shady mortgage companies.