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Single-family homes are seen in a residential neighborhood in San Marcos, Texas, U.S., Tuesday, March 12, 2024. As mortgage rates continue to rise, adding fuel to one of the most unaffordable housing markets in decades, ARMs have gained traction.
CNN
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Last year, when Jennifer Hernandez received notice that her mortgage payments on her Houston home would jump by about $2,000 a month, she was stunned.
Hernandez refinanced her home loan in 2016 using Adjustable Rate Mortgagewhich has a low introductory rate for a fixed initial period.
Unlike more common fixed-rate mortgages, ARMs can offer temporary relief to homebuyers who want to avoid paying higher mortgage rates — however, they also come with risks. After a fixed introductory period — typically five, seven, or 10 years — the interest rate on an ARM loan adjusts periodically based on current market conditions.
That means when mortgage rates rise, many ARM loan holders like Hernandez face the unpleasant shock of a sharply higher monthly home payment. For thousands of Americans like Hernandez who took out ARM loans five years ago, before interest rates rose to four-decade highs, that shock is coming this year.
Mortgage rates remained high.Adding fuel to one of the most unaffordable housing markets in decades, ARMs have gained traction despite their drawbacks.
According to data from InterContinental Exchange, a global technology and data provider, 1.7 million homeowners have purchased homes with adjustable-rate mortgages since 2019. And many buyers who bought five-year mortgages — one of the most popular offerings — will graduate to mortgages with much higher monthly payments this year.
The term of these loans has already been reset for 328,000 homeowners — and an additional 102,000 loans will be reset over the next 12 months, according to ICE.
ARM loans gained notoriety after the subprime mortgage crisis of 2007 and 2008, when many homebuyers were no longer able to make their monthly home payments when interest rates reset.
While the rate of homebuyers choosing ARMs has never recovered to pre-2008 levels, the share of homebuyers using ARM loans has doubled over the past four years, according to the Mortgage Bankers Association.
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An ARM may make sense for homebuyers who are comfortable with the risk of interest rate increases or those who plan to move or refinance before the fixed rate expires, Lorian Jones, a loan counselor in Southern California, told CNN.
But when choosing an ARM, it’s important to keep a close eye on the details, otherwise things can get tricky quickly.
Hernandez, a loan officer, had misremembered the terms of her $1.1 million loan: Instead of a 10/1 ARM, which has a fixed interest rate for the first 10 years and resets each year after that, Hernandez got a 7/1 loan.
“I just got caught,” she said. “Life gets in the way, and you get busy. I’ve been juggling kids and work for the past seven years.”
Last October, Hernandez’s mortgage interest rate jumped 2 percentage points to 5.125%, the maximum allowed in the first adjustment year, according to the terms of her loan.
Most ARMs come with an interest rate cap to keep costs from getting out of control. Hernandez said her ARM is capped at 8.125%, five percentage points higher than her initial fixed rate.
For Hernandez, it didn’t make sense to refinance the loan while the interest rate on the 30-year fixed mortgage was still higher than the new adjusted interest rate. But come October, she suspects her monthly payments will rise even more.
“I made it work, but now I have to figure out how to make it work again next October,” she said. “It’s exhausting to worry about that.”
Andrew Marquis, a loan officer in Lexington, Massachusetts, said he’s seen a big increase in applications for ARM loans recently. Homebuyers increasingly believe the Fed will cut interest rates in the next few years, he said, giving them time to refinance their loans before the ARM expires. The Fed doesn’t directly set mortgage interest rates, but its actions influence them. This year, The Federal Reserve has indicated that It may cut the benchmark interest rate once.
“I would say in terms of the large loans that we do, probably 40% of the loans are ARMs,” Marquez said, referring to loan amounts greater than $766,000.
Marquez said taking out an ARM loan could be beneficial for those with a higher appetite for risk.
“If people can save half a percent on a seven-year ARM versus a 30-year fixed, they’re saving hundreds of dollars a month,” he said.
Interest rates can be unpredictable. Hernandez said she saved money in the first seven years of her loan, but if she could have paid it back, she probably wouldn’t have chosen an adjustable-rate mortgage in 2016.
“This increase in payments was not good,” she said. “I just pray that when the October adjustment comes, interest rates come down a little bit.”
