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Adjustable-Rate Mortgages Are Popular Again. Should You Get One?

By Claire Ballentine

Adjustable-rate mortgages are back in style, as homebuyers opt for lower interest rates now in exchange for the risk of higher payments in the future.

The adjustable-rate option currently makes up the largest share of US mortgages since 2008, comprising 10.8% of total home-loan applications in the week ended May 6, according to data from the Mortgage Bankers Association. That’s up from 3.1% at the beginning of the year. 

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Rising mortgage rates, together with surging home prices, have made adjustable loans look more attractive, especially as first-time buyers try to crack into a housing market that has been running hot for two years. 

In the latest reading from Freddie Mac, a traditional 30-year loan jumped to 5.3%, the highest since July 2009. Meanwhile, the average 5-1 adjustable-rate mortgage — which has a fixed rate for the first five years and then can vary based on market conditions — is 3.98%.

“In a rising rate environment, I think adjustable rates are on the table, but you have to be careful,” said Nela Richardson, chief economist at ADP. “What they do is take the risk of rates rising and pass it onto the consumer.”

Here are some of the pros and cons:

What’s the case for getting one?

If you want a lower rate now. The main advantage of adjustable-rate mortgages is a lower initial rate, which can reduce borrowers’ monthly payment — for now. “As of right now the savings on an adjustable-rate mortgage are quite significant,” said Taylor Marr, deputy chief economist for Redfin. “Some of these buyers are looking for ways to cope with the rising mortgage rates, and opting for a 5-1 adjustable-rate mortgage is a way to do that.”

If you think your income is going to increase. There’s always a risk that the adjustable-rate mortgage will become more expensive if interest rates are higher once the fixed period expires. But for those expecting to make more money soon, that might be less intimidating. “Maybe you’re early in your career and you know you’re on a trajectory where you know your income is going to grow in the next five years, then you might be willing to accept more interest rate risk,” said Frank Nothaft, chief economist for CoreLogic. 

If you’re only going to be in the home for the short-term. If you know that you plan to move again in the near future, an adjustable-rate mortgage could make the most sense, Nothaft said, especially if you choose a 5-1 option— the most popular — or a 7-1 option, which has a fixed rate for the first seven years. This is a common choice for people in the military, who move frequently, or even for first-time buyers with a starter home, who know they will want to upgrade soon. 

If you have a large downpayment. Say you’re lucky enough to pay cash for a significant portion of your home. Then you probably won’t need 30 years to pay off the rest, and an adjustable-rate mortgage can allow you to pay less interest in that shorter timeframe, Marr said. That route is especially popular among people buying vacation homes. 

Reasons to steer clear

If you want less uncertainty in your life. One of the biggest burdens of an adjustable-rate mortgage is the mental toll it can take. Instead of a set-it-and-forget-it option, this kind of loan requires some attention, especially after the initial fixed period ends. At that point, you might need to consider refinancing, or at least monitor the interest rate environment for the duration of the loan. With an adjustable-rate mortgage, “you have to maintain a level of consciousness about your mortgage,” said Melissa Cohn, regional vice president at William Raveis Mortgage. “If you get a fixed rate and it’s locked in at 3%, you never have to think about it.”

If you don’t want to refinance. There’s always the option to refinance for a potentially lower rate, but that can be pricey. “You don’t save costs on refinancing until the new mortgage rate is closer to a full percentage point lower than what your current rate is,” said Marr at Redfin. The average closing cost for a single-family property refinance in 2021 was $2,375, up 3.8% from 2020, according to CoreLogic. 

If you think inflation is sticking around. Although the Federal Reserve is raising interest rates in an attempt to cool inflation, it’s stubbornly persistent. The longer inflation lasts, the longer the Fed may have to keep tightening — potentially bad news for those with an adjustable-rate mortgage, since mortgage rates typically rise alongside benchmark rates. “If you’re in an adjustable-rate mortgage and your window suddenly resets, your mortgage could potentially double or triple,” said David Auerbach, managing director at Armada ETF Advisors. “You’re at the mercy of market interest rates. If your payment goes from $1,000 to $3,000 because of your reset, unless your salary has gone up three times, you’re walking into a pitfall.”

If this is your forever home. For those planning on staying in their property for the long term, an adjustable-rate mortgage can simply be more trouble than it’s worth. The fixed-rate option offers protection from future increases and simplifies your financial life. “We tend to be a fan of fixed rate,” said Nick Holeman, director of financial planning at Betterment. “Your payment is locked in, it’s easier to forecast your long-term budget and plan accordingly for your goals.”

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