As interest rates on mortgages have increased over the past few months, people have increasingly looked to adjustable-rate mortgages (often referred to simply as ARMs) as a way of getting more affordable mortgage payments. This has helped to keep housing demand from falling too much overall, despite rising mortgage interest rates. However, there is a potential cost to the growth of ARMs, which may lead to economic problems in the future.
What Are Adjustable-Rate Mortgages (ARMs)?
Adjustable-rate mortgages (ARMs) are a type of mortgage where the interest rate on mortgage payments can be adjusted by the mortgage lender over the span of the mortgage’s lifetime. In other words, the amount of additional interest on the loan that must be paid back can change, and often that means mortgage payments will increase over time. This is compared to more traditional fixed-rate mortgages, where the interest rate on the mortgage is set when the mortgage is taken out and remains the same until the mortgage is paid off.
Why Are People Applying for ARMs More Often?
For the past decade or so, people have generally avoided ARMs because interest rates were relatively low, so there was little downside to applying for a fixed-rate mortgage. However, with mortgage interest rates climbing, people have been looking to ARMs as an affordable alternative, since they often issue mortgages at a lower initial interest rate. ARMs also generally have lesser credit requirements compared to fixed-rate mortgages, making them easier to obtain for people who might not otherwise be able to afford a mortgage.
What is the Potential Downside to ARMs?
The biggest downside to ARMs is that their lack of a fixed interest rate means that their interest rates can increase over time. This can turn what was previously an affordable mortgage into something the mortgagee can not hope to pay back on their income. As interest rates continue to climb, there is a risk that people who accept ARMs now may find themselves unable to pay them back when the interest on their payments goes up, leading to a higher risk of default.
What Does This Mean For the Market?
The increased number of people seeking ARMs is indicative of how much rising inflation and interest rates have impacted the overall market. With fixed-rate mortgages increasingly out of reach for many prospective homeowners, they have turned to adjustable-rate mortgages as a way of buying the homes they want. And as interest rates continue to climb, their popularity is likely to only increase over time.
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