Adjustable-rate mortgages are gaining momentum

Adjustable rate mortgages are gaining steam in the midst of increasingly challenging market dynamics. 

The ARM share of conventional single-family mortgage originations was 13% in March, a share three times greater than January 2021, according to CoreLogic. Borrowers are turning to this loan type in part because home affordability is at or near record lows and interest rates are exceeding 5%, multiple reports suggest.

“If the mortgage rates on [fixed rate mortgages] continue to increase in the coming years, the share of loans originated with an ARM will likely increase as well,” said Archana Pradhan, principal and economist at CoreLogic, in a new report.

The ARM share of purchase rate locks by volume spiked over the winter from 2.5% in December to 8% in March, according to Black Knight’s March Mortgage Monitor report. The share is the highest since 2017, but still far below the 40% of home purchases made via ARMs in 2005, the firm said.

While the average 30-year fixed interest rate has both sharply decreased and increased over the past two years, ARMs have proven slightly more steady. The ARM rate rose 40 basis points between December 2020 and March 2022, according to CoreLogic, compared to the fixed rate mortgage rate’s rise of 149 basis points over the same period.  

In mid-April, the average 5/1 ARM initial rate was 1.3% lower than the 30-year FRM rate, according to Black Knight. The competitive rates are a relief valve for buyers facing affordability just 1.6% below its all-time worst level in July 2006. The principal and interest payment on an average-priced home accounted for 32.5% of the median income in late April, Black Knight said, or $522 per month more since January.

Today’s ARM borrowers are also less risky, with an average credit score of 757, according to Black Knight. Their healthy credit stands in stark contrast to the 29% of ARM borrowers in 2005 with a credit score below 640, according to CoreLogic. In the lead-up to the Great Recession, 60% of ARMs originated in 2007 were low-and no-documentation loans compared to 40% of FRMs. 

CoreLogic also cited a strong relationship between the average sales price and the ARM share of loans, with high-priced coastal metros recording the largest share of ARMs. Among mortgages $1 million or larger in March, 37% of the dollar volume came from ARMs, up 7% from March, the firm said.

The number of outstanding ARMs is also at its lowest in 20 years, Black Knight found. Still, nearly 1.4 million active ARMs are in the adjustable phase and may face rate and payment increases in the coming months, the technology platform reported.