Adjustable Rate Mortgages Are Quietly Having a Moment

Ever since 30-year fixed mortgage rates fell below 3% last July, headlines have pleaded for homebuyers to take notice of these historic lows.

And why not? We’re living in an unprecedented time. According to the Freddie Mac Primary Mortgage Market Survey (PMMS), the 30-year fixed-rate mortgage (FRM) had never been below 3.3% until the pandemic sent it tumbling into uncharted territory.

But even with 30-year fixed rates still dancing the 3% line, there is a better deal on the table for homebuyers that aren’t necessarily looking for a “forever home.” Historically cheap adjustable rate mortgages -- specifically the 5/1 adjustable rate mortgage (ARM) -- may provide a better value despite receiving almost none of the attention.

According to Freddie Mac, 5/1 ARM rates fell significantly below 30-year fixed rates in early February and haven't returned since. In fact, adjustable rates have been hovering in the mid-2’s since late April and have been as much as 0.41% lower than 30-year FRMs.

In the most recent survey, Freddie Mac reports that 5/1 ARMs average 2.64% compared to 2.99% for a 30-year fixed.

Many new homebuyers were counting on a rate in the mid-2s when they started their home search in 2020. An ARM could be a good way to still capture that rate.

How do adjustable rate mortgages work?

Adjustable mortgage rates remain fixed for a period of time (the first number) before adjusting to current market conditions periodically (the second number). For instance, a 5/1 ARM is fixed at a below-market rate for five years, then adjusts every one year thereafter. There are options for 5-, 7-, and 10-year ARMs. Even 3-year ARMs are offered by some lenders.

These loans come with “caps” which limit how fast and how high the rate can rise after the initial fixed period. Most ARM can’t rise more than 1% per year in the adjustable period, or more than 5% over the life of the loan.

So even if you received a 2.64% rate today, it could never go above 7.64% if it came with the typical cap. But check ARM caps with your lender before accepting an ARM.

How much could I save with an ARM?

At the current rate, ARMS are certainly worth considering, especially for homebuyers that aren’t planning to own their home for more than a decade. This could include first-time homebuyers looking for a starter home or parents that plan on downsizing when the kids (hopefully) move out in a few years.

Let’s look at an example of potential savings, using the most recent data from Freddie Mac

The homeowner who chose a 5/1 ARM in the example above saves over $50 per month and more than $4,000 over five years.

And those savings may come with very little risk.

According to the National Association of Realtors, the median length of homeownership was 13 years in 2018. However, the average stay varies by region. Homeowners in the Northeast metro areas tend to stay longer while homeowners in the West, Midwest, South, Southeast -- pretty much all other metro areas -- tend to move before the 13-year mark.

But it’s not even how long you own the home. It’s how long you have the mortgage. According to Forbes, people hold mortgages an average of only 3-5 years before selling or refinancing.

If your plan is to hold the home or mortgage a short time, an adjustable mortgage rate is worth strong consideration.

Mortgage rate projections are not a reflection of Fairway’s opinion or guarantee of interest rates in the current or upcoming market.

Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.