These days, when you hear people talk about mortgages in America, they're almost certainly talking about a specific, nearly ubiquitous kind of product: the 30-year fixed rate loan.
That's the one that's been climbing to uncomfortably high levels above 7%. (It was 7.67% last week, according to the Mortgage Bankers Association. At the height of the pandemic, it was less than half that.)
But, like everything popular from the '90s and early aughts, there's another kind of mortgage that's having a moment. And just like butterfly clips and low-rise jeans, it comes with a lot of potential for regret.
We're talking about the adjustable-rate mortgage, or ARM, that became something of a relic of the subprime meltdown of the late 2000s, my colleague Anna Bahney writes.
Faced with the prospect of a fixed rate near 8%, homebuyers are desperate for alternatives, and for some, the ARM fits the bill. Last week, the average rate for one kind of adjustable rate mortgage dropped to 6.33% from 6.49%.
A quick history
Back in the late 90s and early 2000s, homebuyers signed on for ARMs at "teaser" rates that later reset and caused monthly payments to balloon above borrowers' ability to pay them. (That's more or less how ARMs became synonymous with words like "predatory lending" and "subprime mortgages" and "oh my God the housing market's collapsing.")
But these days, ARMs are more regulated and transparent. They're still a gamble, because the rate on your loan will move up (boo) or down (yay) depending on a whole bunch of factors outside of your control.
As Anna explains: ARMs offer a fixed rate for a set period — typically five, seven or 10 years — but after that, the interest rate resets to current market rates. A 5/1 ARM, for example, has a fixed rate for five years and then resets every year after that, and there's a cap on how much it can go up or down over the life of the loan.
Why they're making a comeback
The current motto of the Federal Reserve, whose policy choices have a big impact on mortgage rates, is "higher for longer." As in, interest rates will stay elevated for as long as it takes for inflation to come back down to a 2% simmer. But the Fed sees an unusually robust job market and continued strong consumer spending as a sign the economy is still running a fever that could send inflation spiking if the central bank were to back off its monetary tightening plan too quickly.
That makes the prospect of an adjustable rate more attractive.
See here: Say you want to buy median-priced home in America ($407,100), with 20% down, that you expect to live in for 7 years. With a fixed rate loan at 7.57%, you'd be paying $14,500 more over that time period than you would with a 5/1 ARM at 6.33%, even if rates increase when it resets, according to Freddie Mac.
Buyer beware
Those savings are certainly tempting for anyone in that hazy stage of homebuyer mania in which you're ready to commit to eating PB&J every day to land your dream home. High rates, combined with historically low inventory and relentless demand, have turned the whole process into a rat race that buyers are, increasingly, just quitting.
But ARMs still aren't for everyone. Financial advisers say they're best suited for buyers who don't plan to stay long, or who could (somehow) pay off the loan quickly.
If high rates put your dream home out of reach, it be time to take a breather from the housing market, said Jay Zigmont, a certified financial planner and founder of Childfree Wealth, based in Mississippi.
"You shouldn't try to get fancy with your financing just to make your house 'work,'" Zigmont said.
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