Are Adjustable-Rate Mortgages Finally a Good Deal?

If you visit most bank/lender websites and navigate to their home loans section, you’ll likely only see fixed-rate mortgages advertised.

This made perfect sense over the past several years because interest rates on popular mortgage products like the 30-year fixed were at record lows.

There was basically no need to look beyond it given the ultra-low rate and the security of a fixed interest for the entire loan term.

But that was then, and this now. Today, the 30-year fixed mortgage is hardly a deal, with many priced in the 7-8% range (or higher).

That begs the question; are adjustable-rate mortgages finally worth considering?

Are ARMs Worth Considering Again Now That 30-Year Fixed Mortgage Rates Are Nearing 8%?

In recent years, the adjustable-rate mortgage became a bit of a niche product.

Last year, about 75% of the home loans funded featured a fixed interest rate, per HMDA data.

And nearly 60% were 30-year fixed-rate mortgages, which are far and away the most popular loan choice.

As noted, low fixed rates meant there wasn’t much need for anything else, barring the ultra-wealthy who may have taken out ARMs at rates as low as 1%.

But for most homeowners, a 30-year fixed, or perhaps 15-year fixed, was all they really needed.

And now homeowners who took out these loans in 2021 get to enjoy another 28 years of fixed rate goodness at rates as low as 2-3%.

In case you haven’t heard, this is known as the mortgage rate lock-in effect, where existing homeowners are unable or uninterested in trading in their home loan for one at today’s much higher rates.

Anyway, while that’s great for existing homeowners, but what about prospective home buyers, or those who don’t have a super low, locked-in rate?

Well, it might be time to take a look at an ARM again, now that fixed mortgage rates are through the roof.

The spread between products like the 30-year fixed and 5/1 ARM is now wide enough to consider the discount.

In the recent past, both the 5/1 ARM and the 30-year fixed were priced very similarly, making it a no-brainer to go with the fixed rate. But this is no longer the case.

Just be sure to shop around carefully and extensively, as ARM rates are notoriously more variable, no pun intended.

How Much Can You Save With an ARM?

Depending on the difference in rates, you could save a pretty penny with an ARM vs. fixed-rate mortgage, but the savings can vary tremendously.

Ultimately, the savings need to justify the risk of the variable rate, as the ARM can adjust higher once the initial fixed period comes to an end.

This is why you pay a premium for a 30-year fixed-rate mortgage, since the interest rate is locked for the entire 30-year loan term.

The ARM, on the other hand, can adjust, often 2% higher, at the first adjustment.

In our example above, the 5/1 ARM is fixed for the first 60 months, then subject to an annual adjustment for the remaining 25 years.

But our hypothetical borrower could save about $35,000 during those initial 60 months and they’d have a lower balance thanks to a reduced interest rate.

Thanks to the way mortgage amortization works, more of each payment would go toward the principal balance at the lower interest rate.

This could make it easier to refinance in the future when the ARM becomes adjustable.

Who Offers Adjustable-Rate Mortgages These Days?

Not all banks and lenders offer adjustable-rate mortgages. And even if they do, they may not offer much of a discount for the risk and uncertainty of an ARM.

For example, Wells Fargo advertises a 7/6 ARM, but the discount is only .125% for jumbo loans, and a slightly better .375% for conforming loans.

Meanwhile, some local credit unions are offering ARMs at more than 1% below their fixed-rate options.

I did some digging to see what was out there and was surprised to see such a range of rates and options.

This is why you need to be very thorough if you’re sold on the idea of an ARM. While fixed-rate products can range from lender to lender as well, they tend to vary less.

To illustrate, I found that Credit Union of Southern California was advertising a 30-year fixed at 8% (yes 8%!), while their 5/1 ARM was priced at 6.25%.

That’s a whopping 1.75% difference in rate. If we’re talking a $500,000 loan amount, the monthly payment is nearly $600 lower on the ARM.

We’re talking a principal and interest payment of $3,078.59 versus $3,668.82. And an outstanding balance of roughly $467,000 after five years vs. $475,000.

There’s an even cheaper option at California Coast Credit Union, which is advertising a 6.125% rate on a 5/1 ARM (vs. 7.875% on their 30-year fixed).

Then there’s Wescom Credit Union, which is currently advertising a rate of 8.25% on a 30-year fixed with no points, and a 5/6 ARM at 6.875% with no points.

A slightly smaller margin here of 1.375%, but still a large discount to be had on the ARM.

Another big discount can be seen at Randolph-Brooks Federal Credit Union (RBFCU), where their 30-year fixed is advertised as low as 7.375% and their 5/5 ARM as low as 6.25%.

The 5/5 ARM is unique in that it adjusts once every five years after the initial five years are up. This could be good or bad depending on where rates are in year six.

Remember I said you had to be a diligent shopper. Well, Boeing Employees’ Credit Union, or BECU for short, is advertising a 5/6 ARM at 8.061% APR.

They’re even higher at Bank of America, which is advertising a 5/6 ARM, 7/6 ARM, and 10/6 ARM all at 8.5%.

In other words, you’d be better off getting a 30-year fixed in the 7% range instead.

Some Lenders Have More of an Appetite for ARMs Than Others

As for why ARM pricing can vary so much from bank to bank, or credit union to credit union, it has to do with appetite. And I suppose profit margin too.

Some companies may have more interest in originating and holding ARMs in their portfolio, while others may not as be interested but still offer them. And credit unions are not-for-profit financial institutions.

This is why the rates might be higher at the big banks, who may still want to offer the full menu of loan programs without being competitive.

Conversely, the credit unions seem to be fighting harder to win business, and are more willing to offer markedly lower rates relative to their fixed-rate offerings.

Another example is Navy Federal CU, which is advertising interest rates as low as 5.125% on a 3/5 ARM, which adjusts after just three years (then adjusts every five years).

Meanwhile, Chase, which was the top adjustable-rate mortgage lender last year, is advertising a 5/6 ARM at 6.75%.

But other banks are more competitive, such as KeyBank, which was advertising a rate of 5.875% on its 5/6 ARM and 7.5% on its 30-year fixed (for clients in Ohio). That’s a whopping 1.625% difference.

To sum things up, adjustable-rate mortgages are beginning to make a lot more sense given the large spread in interest rates.

But you need to shop carefully as pricing seems to be all over the map from one lender to the next.

And for the most part, the credit unions seem to be offering the best rates. If you’re curious what’s out there, just start searching for banks and CUs in your state to see what you find.

Is an ARM a Good Idea in 2023?

As stated earlier, ARMs are inherently more risky than fixed-rate mortgages. After all, they can adjust higher after the typical 3, 5, or 7-year fixed period comes to an end.

The shorter the fixed period, the riskier, as you’d have less time to act if your rate reset higher.

While most ARMs have caps in place that limit rate movement, often maxed out at 2% for the first adjustment, going from a rate of 6.125% to 8.125% could still be a shock.

It isn’t a guarantee that the rate would adjust higher, but you need to consider it and be prepared for such an outcome if you take out an ARM.

You also need a plan in place for when that first adjustment comes. Do you plan to sell your home before then or refinance to another ARM or possibly a cheaper fixed-rate mortgage?

It all boils down to where mortgage rates land in the next five years. Will they be lower? Possibly. But they could be the same or worse. Nobody really knows with any certainty.

Granted, the Fed’s own target rate is projected to be lower by the end of 2024, and mortgage rates are also predicted to be lower by most economists.

And they could improve even more from there in 2025 and beyond. So an ARM taken out today could serve as a bridge to a lower rate in the future. You just have to prepare for the worst since you don’t have the security of a fixed rate.

Read more: What to do if your adjustable-rate mortgage is about to adjust.