Analysis | Adjustable Mortgage Rush Isn’t the Same as 2008

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Adjustable-rate mortgages are beginning to look good again. As the cost of owning a home continues to soar, more buyers are willing to take their chances with the floating interest rate that got so many borrowers in trouble when the housing market crashed in 2008. But don’t worry, so far there’s nothing that alarming happening.

ARMs, as they’re popularly known, typically offer lower rates to start off than traditional 30-year fixed mortgages, but then bounce around with the market. While ARMs come in all shapes and sizes, the most common ones feature rates that reset annually based on the current market after five, seven or 10 years.

Borrowers can get into hot water with ARMs because their monthly payments can jump suddenly if interest rates move higher. Homeowners can always try to refinance before the rate resets, but that means they have to monitor where rates are and try to guess where they’re headed. During the most recent housing bust homeowners faced a double whammy — their lower initial rates spiked as their houses plunged in value. Many homes were lost to foreclosure.

Five-year ARMs have long been the most popular option, since their initial rates are usually much lower compared with a 30-year fixed mortgage. But estimates by the Mortgage Bankers Association show that more than half the applications for new ARMs are for longer terms, with rates that reset after seven or 10 years.

That seems to indicate that borrowers are being more careful this time. Given the uncertainty around where rates and the economy are headed, they would rather pay more and lock in a rate for longer than just go with what’s cheapest.

For example, the average rate offered for a 5/1 ARM (which means the interest rate will reset every year after five years) is 3.84% compared with 4.75% for a 7/1 ARM and 4.87% for a 10/1 ARM, according to Bankrate. For a 30-year fixed mortgage, the average rate right now is 5.39%.

What’s more, while the MBA data show that ARMs have ticked up to account for their largest share of overall mortgages since 2008, they are still just 11% of the market. In the run-up to the housing crisis, ARMs accounted for well above 30% of all mortgages.

Refinancing old mortgages into new ones with lower rates has made up a bigger share of the market in recent years. Since refinancings are a smaller part of the overall mortgage market now as rates rise, it’s only natural for ARMs to be picking up some of the slack.

It’s also reassuring to look at who is actually choosing ARMs. They’re more common among buyers borrowing larger balances, according to data from CoreLogic. For $1 million-and-up mortgages, ARMs comprised 37% of the dollar volume as of March, the biggest increase from a year earlier. For mortgages in the $400,001 to $1 million range, the ARM share was about 10% and for mortgages from $200,001 to $400,000, ARM share was just 4%, CoreLogic data show.

And unlike the heady days leading up to the mortgage meltdown, the ARMs offered now require more documentation and higher credit scores, and they aren’t ultra-short-term like 1/1 or 3/1 ARMs that used to be common.

These days, deciding whether an ARM is a smarter move than a fixed-rate mortgage really depends on factors such as how long you plan to be in the home and your expected income trajectory. If you know you will sell before the rate resets, an ARM can make sense (but keep in mind time can fly and the typical homeowner spends 13.2 years in a house).

It’s hard to give one-size-fits-all advice here, but if your only reason for doing an ARM is because you want to rewind the clock to where rates were a few months ago, think twice.

ARMs aren’t for everyone, but even with more borrowers doing them, there is no reason to think the housing market is headed for disaster.

More From Other Writers at Bloomberg Opinion:

• Housing Defies Fed’s Campaign to Curb Inflation: Jonathan Levin

• A Brontosaurus Moment Is Finally Waking Up Markets: John Authers

• A Stronger Housing Market Can Withstand a Hawkish Fed: Conor Sen 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

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