Adjustable-rate mortgages, known as ARMs, are back, despite having earned a bad reputation at the height of the housing crisis.
Post-crisis borrowers saw them as risky because of their changing interest rates and blamed the glut of foreclosures on the inability of homeowners to handle higher payments when the loans reset.
“ARMs became a four-letter word after the housing crisis,” says Ann Thompson, a retail sales executive for Bank of America in San Francisco. “They got a bad rap and were lumped in with ‘pick-a-payment’ loans, which allowed people to pay as little or as much as they wanted on their mortgage.”
Lately there’s been a resurgence in ARMs. In January 2019, 8.6 percent of new mortgage loans had an adjustable rate, compared with 5.5 percent in January 2018, according to Ellie Mae, a software company that processes 35 percent of mortgages in the United States.
One reason for the resurgence could be the safeguards in place that make today’s ARMs less risky than those approved during the frenzied days before the housing bubble burst. Not only are there limits on how much a mortgage rate can adjust, but most ARMs today are “hybrid” loans with a fixed period followed by annual adjustments in the rate. Caps are in place to prevent the mortgage rate and payments from rising too fast.
Perhaps most importantly, lenders no longer qualify borrowers on the initial low payment. Instead, they qualify them based on what future payments will be after the rate adjusts.
“In the past, one of the most popular ARMs was a ‘2-28’ which was fixed for two years and then adjusted every year after that,” says A.W. Pickel, president of Waterstone Mortgage in Pewaukee, Wisconsin. “Mortgage rates could go very quickly from an initial rate of 6.5 percent to 13.5 percent.”
Borrowers in those days were approved for ARMs without a down payment and with little documentation of their income and assets, which meant they lacked the equity to refinance and faced unsustainable payments when their rates increased.
“You used to see ARMs that adjusted every six months or every year from the very beginning,” says Claudia Mobilia, senior vice president of operations for Embrace Home Loans in Middletown, Rhode Island. “You don’t see that anymore.”
The ARMs of the past also included a prepayment penalty that discouraged borrowers from refinancing, says Shawn Sidhu, a mortgage consultant for C2 Financial in San Jose.
“A lot of people with credit issues or who couldn’t afford the payments on a 30-year fixed-rate mortgage turned to ARMs to get into the housing market,” Sidhu says. “Those people were not good candidates for ARMs.”
While ARMs are safer than in the past, they still carry a risk of an uncertain payment in the future.
“The rates on ARMs can be significantly lower than on a fixed-rate loan, so I hope that buyers and homeowners who are refinancing consult a mortgage professional who can talk them through all their options,” Thompson says. “Lots of people don’t stay in their home for that long, so an ARM can make sense. They just have to understand what it could look like if they do stay after the loan adjusts.”