Adjustable rate mortgages are back.
After accounting for nearly 70 percent of all mortgages issued during the boom, ARMs vanished during the bust, totaling just 3 percent of the market in 2009. Now they make up 5 percent of all mortgages issued, and Freddie Mac predicts 10 percent by December.
Behind the comeback: The most common ARM loan has a rate of 3.5 percent compared to around 5 percent for a 30-year fixed-rate mortgage.
“For anyone with a high likelihood of moving soon, the 5/1 is a great product,” said Michael Fratantoni of the Mortgage Bankers Association.
Fixed vs. ARM
Fixed-rate mortgages are seen as safer because they carry the same rate over life of the loan and the payments stay the same.
With ARMs, interest rates change over time. For example, the 5/1 ARM — the most common loan — has the 3.5 percent introductory rate for the first five years. After that, the rate adjusts annually.
That sounds risky, but look deeper. On a $200,000 mortgage, the monthly ARM payment at 3.5 percent would be $898 compared with $1,074 for a 30-year, fixed-rate loan at 5 percent.
That’s a $10,560 difference after five years, when the ARM would adjust. At that point the ARM rate could jump to a worst-case scenario 8.5 percent and the monthly payment to $1,538.
It would take more than 22 months of the higher ARM payments to offset the first five years of savings.
Bad memories
Still, many homebuyers want no part of ARMs, particularly as the housing market struggles to emerge from the recession.
Many buyers remember the toxic or exploding ARMs and how their defaults triggered the mortgage meltdown, helped sink the housing market and usher in the Great Recession.
These loans failed for a couple of reasons. Many were issued to people who lacked the income to pay once the initial years of low fixed rates ended and the interest rate reset higher. Also, such loans went to low-caliber borrowers.
Unlike a toxic ARM, the 5/1 is issued to borrowers with high credit scores, making substantial down payments and with assets, debt and income carefully underwritten before approval.
