With mortgage rates nearly doubling from 2021 to 2022, many homebuyers are taking a second look at adjustable-rate mortgages (ARMs). In fact, applications for ARMs have tripled since the beginning of 2022.
A popular loan in the housing bubble of the mid-aughts, few borrowers have used them in recent years, given how low interest rates stayed. But skyrocketing real estate prices and interest rates have given a shot in the ARM to this once-dismissed loan.
But does desperation justify this risky type of mortgage? It can — for some borrowers.
Is an Adjustable-Rate Mortgage (ARM) a Good Idea in 2022?
Adjustable-rate mortgage loans start with a fixed, low interest rate for an introductory period, usually five, seven, or 10 years. Then it starts adjusting based on market interest rates, based on a benchmark like the LIBOR or Federal Reserve funds rate.
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This increase builds in a large profit margin for the mortgage lender. Which usually means a big jump in interest rate — and in your monthly payment. The most common ARM structure, a 5/1 ARM, comes with a low initial interest rate for five years, then the rate changes every year.
But rising interest rates have pushed homeownership out of reach for many Americans. After all, higher interest rates mean a higher monthly payment for the same purchase price, lifting the real cost of owning a home.
While higher interest rates might push down housing market prices, this isn’t guaranteed. Meanwhile, ARMs offer interest rates often an entire percentage point lower than 30-year fixed mortgages, sometimes more. And the gap has only widened in 2022, with ARMs now offering even lower mortgage interest rates than 15-year-fixed loans according to Freddie Mac:
That can put homeownership back on the table for some first-time home buyers — if they don’t mind the risks of an ARM. A one-point difference in interest rate can mean hundreds of dollars’ difference in the monthly payment. For example, a $400,000 loan costs $1,968 per month at a 4.25% interest rate, but $2,209 at a 5.25% rate.
The Verdict: Should You Choose an ARM Loan or a Fixed-Rate Mortgage in 2022?
The greatest factor in your decision should come down to whether you plan to repay the loan in full before the fixed-interest period ends. That could mean selling your home and moving, or it could mean paying off your mortgage early.
Your risk tolerance also matters. You could roll the dice on interest rates falling back down before your ARM’s fixed-rate period ends. But even if they do, you’d still need to pay thousands of dollars to refinance your mortgage and lock in a lower rate.
You Should Get an ARM If…
An adjustable-rate mortgage is a better fit if:
- You Plan on Paying Off Your Loan Within 5 to 10 Years. You can take out ARMs with a low fixed-interest period for up to 10 years. If you plan on knocking out your mortgage loan before the introductory rate period ends, it’s a moot point.
- You Plan on Selling Within 5 to 10 Years. The same logic applies if you plan on moving again before the fixed period ends.
- Your Priority Is Becoming a Homeowner. If you want to get your foot in the door with a starter home and move in a few years, an ARM can help. However, if you think your starter home might end up being your forever home, an ARM could cost more in the long run.
- You Don’t Mind Gambling & Refinancing. Mortgage rates might fall back down before the initial period ends and the rate adjustments start. But even if you’d take that bet, you still have to swallow the bitter pill of refinancing fees and costs.
You Should Get a Fixed-Rate Mortgage If…
A fixed-rate mortgage is a better fit if:
- You’re Buying Your Forever Home. In a fit of exasperation, my father once told my stepmother that she will “peel his dead body off this kitchen floor,” because he’d had enough of moving. If you find your forever home and never want to move again, a fixed-rate mortgage holds your principal and interest payment steady for the entire term.
- You Plan on Leaving Your Loan in Place. Many people have no intention of paying off their mortgage early, or at least not within the next 10 years. If that sounds like you, get a fixed-rate loan.
- You Want Peace of Mind. Similarly, some people hate deadlines or uncertainty looming over them. Even if you aren’t sure whether this next house will be your forever home, you might sleep better at night knowing that your monthly mortgage payment won’t ever leap skyward.
Before you do anything else, run the numbers on how much house you can afford. Figure out your target monthly payment, and then work backwards to calculate how much you can afford to offer based on either a fixed-rate mortgage or ARM.
If you don’t mind a time limit on paying off your home loan, consider an ARM for the lower monthly payment and higher price cap. You may not have any intention to stick around more than five years anyway.
But if you don’t know what you’ll want in a decade from now, lock in a fixed interest rate as soon as you get a home under contract. You’ll have higher payments in the short term, but you don’t need to worry about market conditions or higher rates when your rate resets and the adjustment period begins.