In the beginning of November, 2022, after numerous rounds of rate hike throughout the year with attempts to combat against inflation, the Fed officially announced that we can expect another 75 points hike within the next couple months, which will drive the rate from 7.5 to 8% – the highest average since April of 2002, according to Freddie Mac.
To put that into perspective, Nadia Evangelou, the Senior Economist of National Association of Realtors, stated that the average monthly mortgage is now $1,000 higher comparing to a year ago, which led to a huge drop in mortgage applications for purchases and refinancing. And sadly, there’s nobody for us to blame. So how do home buyers and lenders adjust to this brutal market? Here comes Adjustable Rate Mortgage, or ARMs.
A brief definition of Adjustable Rate Mortgage
Adjustable-rate mortgage is a product offered by many lenders that has an interest rate that may change periodically depending on not only the terms borrowers agree on but also the changes in the respective financial index. With that being said, unlike the traditional fixed-rate mortgages, your monthly payment may go up or down depending on the market condition.
ARM typically has lower rate due to the unpredictable risks borrowers typically take on in case the rate hikes aggressively after the fixed-rate terms agreed up on.
Of course, I will cover ARM in much greater details in future article. This is mainly for additional context.
Why is Adjustable Rate Mortgage relevant here?
According to a Freddie Mac’s report of the week ending in October 27th, 2022, here’s the national averages with mortgage rates:
- 30-year fixed-rate: 7.08% with an average 0.8 point, up from averaged 3.14% a year ago.
- 15-year fixed-rate: 6.36%, with an average 1.4 point, up from averaged 2.37% a year ago.
- 5-year adjustable-rate: averaged 5.96%, with an average 0.3 point, up from averaged 2.56% a year ago.
ARMs, in the Real Estate world, is known as the double-edged sword. Back to the current conditions of the market with high interest rates, lenders start countless of marketing campaigns on ARMs attempting to assist borrowers to lock in a much lower introductory rate for a set period of times before the rate changes either higher or lower in the future. Of course, at first, lower rate may seem like an appealing option. However, it yields high level of risks if home buyers do not have a long-term game plan in place.
Imagine a scenario when after 5 or 7 years of closing your mortgage, the rate increases to a much higher rate to the point that you can no longer afford your monthly payment. What would you do then? We all know by that point, the lenders reserve the rights to take over your home if you do not pay them back, which leads to either a foreclosure or property short-sale. As a matter of fact, Adjustable-Rate Mortgage played a bug factor that caused the 2008-2009 housing market crash due to the complexity and people’s lack of knowledge on the product. Don’t believe me? You can watch or read the Big Short here.
Here’s even a worser news! Since the beginning of this year 2022, Adjustable-Rate Mortgage applications reaches the highest level since 2008, which shows a very similar pattern that leads to the previous housing crisis.
There will be shake-ups but not crash
Since the previous market crash, there are many ongoing changes and regulations put on the lending industry. ARM is not any different comparing to other mortgage products. With the new regulations and restrictions, Adjustable-Rate Mortgages are less risky now. Besides much stricter underwriting regulations and educational contents on the product now, as I previously mentioned here, the initial fixed-rate period of an ARM product now commonly lasts between 5, 7, and 10 years. Comparing to a much shorter period of less than a year or so back in 2008, this is a much longer grace period, which offers additional reassurance and time to prepare to borrowers.
Additionally, most lenders now offer additional protections on their ARM products that shield them from unreasonable increase at the end of the fixed-rate period, the changes happening annually, and the highest rate one can reach. Obviously, these protections can only protect borrowers to a certain extent. But by the time the rate increases, it’s still the borrowers’ job to make sure they can still afford the new monthly payment.
Food for Thought
For more information, you can reach out to our Mortgage Department by emailing mortgage@chadvorealestate.com.
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