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Millennials Seem to Like Adjustable Rate Mortgages

avo toast

It’s not just avocado toast.

A new anecdotal report from the WSJ reveals that Millennials who are buying homes are increasingly choosing adjustable-rate mortgages to get the job done.

While the data isn’t definitive by any stretch, John Walsh, the chairman of a large mortgage lender by the name of Total Mortgage Services, told the publication that interest in 7/1 ARMs jumped 18% from a year ago.

He tells the WSJ that these home buyers aren’t “going to work at GE for the next 30 years,” which explains why they would choose an ARM instead of a fixed-rate mortgage.

In a word, they’re “mobile.” The argument is basically that they won’t be staying in the home for 30 years, and as such won’t be keeping the mortgage very long either.

It Doesn’t Take Long to Outgrow a Home

  • Today’s young home buyers realize they may not stay long
  • Either because of increased job mobility
  • Or simply because they’ll outgrow their homes and need larger ones
  • This makes an ARM a compelling mortgage choice over a FRM

It’s a pretty safe bet to make because these first-time buyers will likely outgrow their homes within a decade or less, especially if they advance in their careers and increase their purchasing power (and start families).

Of course, that’s the simple way of looking at it. We could have made the same argument about 10 years ago.

Back in 2006, a young home buyer could have (and probably did) take out an ARM because they didn’t plan on staying in their home for more than say five years. Or they just serially refinanced because they could.

But just a few years later, they were essentially trapped in their homes thanks to plummeting home prices.

The lack of home equity meant they couldn’t sell or refinance into a fixed-rate mortgage, so they were stuck with an ARM they never expected to keep past its first adjustment.

Ironically, many of these ARMs actually fell in price (rate) because associated mortgage indexes also sank during the crisis, giving these risky borrowers the surprise gift of a lower monthly payment.

Now it may not go down that way again (let’s hope not), but it easily could turn into a situation where mortgage rates rise significantly during the ARMs initial fixed period.

After the seven years are up on a 7/1 ARM, and the first adjustment takes place, the borrower could see their monthly payment skyrocket (within the initial caps allowed).

At that point, they’d have to weigh their options. They could sell, assuming they had the equity and a new place to go, refinance if rates were attractive, or panic if they were unable to do either.

Still, if such a borrower were saving money for 84 months, and paying down their principal balance faster thanks to a lower interest rate, they’d likely be in a position where they had some good options.

Is an ARM Right for a Young Homeowner?

  • You can definitely make the argument for an ARM
  • Especially those that are fixed for the first 5 or 7 years
  • Because many home buyers move in a decade or less
  • So the risk of a rate adjustment may not actually materialize in real life

You can certainly argue yes. As noted, many young buyers don’t stay in their first home. It’s very common for first-timers to move after a few years. Heck, it’s common for everyone to move every five years or so.

If you factor in a rising salary, perhaps thanks to a promotion as the borrower moves up the corporate ladder, the ARM becomes less risky.

But it definitely needs to be given a lot of thought. Every borrower should sit down and try to map out a five-year plan, a 10-year plan, and so on.

An ARM has the ability to save a homeowner lots of money, and because these aren’t their older siblings ARMs, they actually pay down the balance each month and certainly don’t amortize negatively.

Additionally, most are fixed for the first five or seven years, not just the first six months, meaning the borrower will likely never even face an interest rate adjustment.

The other side of the coin is that fixed-rate mortgages are still priced very, very attractively, and not far from record lows. Why not grab one while it’s so cheap?

If the ARM payment doesn’t represent a substantial discount to the fixed-rate option, why bother?

Also, if a young buyer starts in a condo or a starter home, it’s quite possible they could rent it out when they go to buy their next property. Having a really cheap fixed mortgage on that puppy could be a pretty sweet deal for the next three decades.

(photo: T.Tseng)

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