Last year, Jennifer Hernandez was shocked when she received notice that the mortgage monthly payments on her Houston home would increase by about $2,000 per month. Hernandez had refinanced her home loan in 2016 using an adjustable-rate mortgage (ARM) loan, which offers a low introductory rate for a fixed initial period. Unlike the more popular fixed-rate mortgage loans, ARMs can provide temporary relief for homebuyers who want to avoid paying higher mortgage rates, but they come with significant risks. After the fixed introductory period — typically five, seven, or ten years — the rate on an ARM adjusts periodically based on current market conditions.
When mortgage rates rise, ARM loan holders, like Hernandez, often face the unpleasant surprise of significantly higher monthly home payments. This year, thousands of Americans who took out ARM loans five years ago, before interest rates soared to a four-decade high, are experiencing this shock.
Elevated mortgage rates have exacerbated the affordability crisis in the housing market, leading ARMs to gain traction despite their potential drawbacks. According to data from Intercontinental Exchange (ICE), a global provider of technology and data, 1.7 million homeowners have purchased homes with adjustable-rate mortgages since 2019. Many buyers who opted for five-year ARMs — one of the more popular offerings — will see their monthly payments rise significantly this year.
The fixed period for these ARMs has already reset for 328,000 homeowners, and another 102,000 loans will reset over the next 12 months, according to ICE. ARM loans gained a bad reputation following the subprime mortgage crisis of 2007-2008, when many homebuyers could no longer afford their monthly payments once their rates reset. Although the rate of homebuyers choosing ARMs never rebounded to pre-2008 levels, the share of homebuyers using ARM loans has doubled over the past four years, according to the Mortgage Bankers Association.
Lorriane Jones, a loan consultant in Southern California, explains that an ARM might make sense for homebuyers comfortable with the risk of interest rate increases or those who plan to move or refinance before the fixed rate expires. However, it’s crucial to pay close attention to the loan’s details to avoid potential difficulties.
Hernandez, a loan officer herself, had misremembered the terms of her $1.1 million loan. Instead of a 10/1 ARM, which has a fixed rate for the first ten years and then resets annually, Hernandez had taken out a 7/1 loan. “I just got caught blindsided,” she said. “Life gets in the way, and you get busy. I’ve been slammed with kids and work for the last seven years.”
In October, Hernandez’s mortgage rate jumped by 2% to 5.125%, the maximum allowed in the first adjustment year according to her loan terms. Most ARM loans come with an interest rate cap to prevent costs from spiraling out of control. Hernandez’s ARM is capped at 8.125%, five percentage points above her initial fixed rate.
Given that the 30-year fixed mortgage rate remains higher than her new adjusted rate, Hernandez finds little sense in refinancing her loan. However, she anticipates that her monthly payments will rise again this October. “I’ve made it work, but now I’m going to have to figure out how to make it work again this October,” she said. “It’s stressful having to worry about it.”
Andrew Marquis, a loan officer in Lexington, Massachusetts, has observed a dramatic increase in ARM loan applications recently. He notes that homebuyers increasingly believe that the Federal Reserve will cut interest rates in the next few years, allowing them time to refinance their loans before the fixed period of their ARM expires. The Federal Reserve doesn’t directly set mortgage rates, but its actions influence them. This year, the Fed has indicated the possibility of cutting its benchmark interest rate once.
“I would say on the jumbo loans we’re doing, probably 40% of the loans are doing ARMs,” Marquis said, referring to loan amounts above $766,000. He suggests that taking out an ARM loan might be worthwhile for those with a higher risk appetite. “If people can save a 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. While Hernandez saved money during the initial seven years of her loan, she now regrets choosing an adjustable-rate mortgage in 2016. “This increase in payments hasn’t felt good,” she said. “I’m just praying that when my October adjustment comes around, rates have come down a little bit.”
