Adjustable-Rate Mortgages in 2022

An adjustable-rate mortgage or ARM is a home loan that starts with a lower introductory interest rate for up to 10 years, followed by periodic rate adjustments. In contrast, a fixed-rate mortgage keeps the same interest rate for the life of the loan.

ARMs have not been popular over the last decade, but they are making a comeback in 2022 for good reason. If used right, an ARM can be an appealing option for informed buyers in a rising market.

When an ARM loan might be a good option

• The added savings of a lower introductory rate helps one afford a home purchase today, with the understanding that the interest rate and payment may rise at a future date. Make sure to speak with your Intercap loan officer to understand your ARM options and terms.
• The buyer plans to sell, refinance, or pay off the loan before the adjustment starts. Statistically, the average lifespan of a US mortgage is under 10 years*.
• Seven-to-ten-year ARMs are more popular than shorter-term ARMs. This gives buyers more time to potentially gain equity, sell, or refinance.
• The buyer expects more income before the rate adjustment starts.

The history of ARMs

ARMs got a black eye after the housing crash in 2008. They were lumped in with other sub-prime loans that led to an unprecedented number of mortgage defaults. The most problematic ARM loans of the time had shorter introductory rates – 2 to 3 years – and higher rate adjustments after the teaser period. Most ARM buyers expected to sell their properties or refinance before the higher payments kicked in. Those caught in the crash saw their homes lose value as their mortgage payments went up. For many, selling or refinancing wasn’t an option.

After the crash, fixed-rate loan interest rates were low enough that ARMs lost their appeal. Housing prices also dropped due to depleted demand and an increase in housing inventory. Those who could buy, saw the 30-year fixed loan as the best mortgage option. This sentiment still resonates with many buyers. Interestingly, the average US mortgage holder sells, refinances, or pays off their mortgage in under 10 years*.

The ARM option is picking up steam in this current market of high buyer demand and rising interest rates. The ability to qualify for a lower introductory interest rate appeals to buyers who know they will be able to afford the future rate increase or pay off their home.

How ARMs Work

The introductory and adjustment period are clearly defined in the terms of an ARM loan. For example, a 10/1 ARM means the introductory rate period is 10 years with an annual adjustment for the rest of the loan term, usually adding up to 30 years. Rate caps are also defined to limit how much a rate can go up during the adjustment periods.

The introductory rate is fixed. The adjustment rate is variable based on the index rate plus a margin defined by the lender. If the index rate falls (the current interest rate), the mortgage payment may decrease. If the index rate goes up, the mortgage payment may go up. This adjustment can happen annually or bi-annually depending on the ARM terms.

With this 10/1 ARM example, the second number indicates how often the variable rate is adjusted. In this case, once a year.

ARM Caps

Caps help to keep the rates from adjusting up too sharply during the adjustment periods. In other words, there are caps on the adjusted increase based on the current index rate and the margin set by the lender. A common rate cap is 2/1/5. The first number represent the most the interest rate can increase the first year of the adjustment period. The second is the most it can adjust every year thereafter. And the third represents the lifetime cap.

For example, let’s say the introductory rate is 3% on a 10/1 ARM with a 2/1/5 cap. The most the rate could increase year 11 is 2%, for a capped rate of 5%. And over the life of the loan, the most the annual rate could be is 8% – 3% initial rate and a max increase of 5%. Caps may not be reached based on the current index rate and margin, but they will never be surpassed.

Speak to your Intercap loan officer to discuss all your loan options. They are experts at understanding which options may be most ideal for your situation and goals.

*NAR (Mar 2021) https://www.nar.realtor/sites/default/files/documents/2021-home-buyers-and-sellers-generational-trends-03-16-2021.pdf