Rising Demand for Adjustable-Rate Mortgages Amid Record High Conventional Home Loan Rates

The National Association of Realtors (NAR) has observed a rising interest in adjustable-rate mortgages (ARMs) as traditional home loan rates continue to climb, recently reaching an unprecedented 8%, the highest level since August 2000. Current ARM rates range between 7.12% and 7.65%. These mortgages come in various forms—fixed for 3, 5, 7, or 10 years—before moving to a floating-rate period, where the rate adjusts according to market conditions.

For instance, a typical 5/6 ARM locks in the rate for the first five years, followed by biannual adjustments. NAR indicates that ARMs can be advantageous for homebuyers who plan to sell during the fixed-rate phase or for those with variable income sources. With the current 8% interest rate, a median-priced home at $394,000 would incur monthly payments of approximately $2,891 using a 5/1 ARM. However, this monthly cost could increase significantly to $3,720 if rates were to rise to 12% by 2028.

While ARMs provide initial savings with their lower rates compared to conventional loans, the uncertain nature of future rates means long-term savings can be unpredictable. Financial advisory services have warned potential borrowers who prefer fixed monthly payments to carefully consider the rate fluctuations associated with ARMs.

ARMs transition from a fixed-rate term to a variable rate based on interest rate indexes, plus an added margin from the lender, generally with limits on how much rates can increase. Various types of ARMs exist, such as 5/1, 5/6, 7/1, 7/6, 10/1, and 10/6 ARMs, along with options like payment choice ARMs, interest-only ARMs, and convertible ARMs. While they offer lower initial rates and flexibility, they also come with risks of potential rate hikes and budgeting challenges.

Lenders evaluate multiple factors when considering ARMs, including the borrower’s credit score (ideally a FICO score of 620 or higher), income, and debt history, often favoring a down payment of 5%. Some ARMs may include a "teaser rate," which poses a risk for increased future payments. Refinancing an ARM into a fixed-rate mortgage may also incur penalties and closing costs.

With mortgage rates at a 20-year high, it’s essential for prospective borrowers to be aware of prepayment penalties and to seek offers with no points while comparing ARMs. Currently, there is only a minimal difference—less than 1%—between the rates of a 30-year fixed mortgage and the introductory rate of a 5/1 ARM. When selecting an ARM, it’s also important to weigh considerations like principal and interest payments and the availability of conversion options.

This article was generated with the support of AI and reviewed by an editor.