As 30-Year Fixed Mortgage Rates Rise, Are ARMs a Better Option?

Mortgage rates are surging to new highs in tandem with the Federal Reserve’s upward pressure on the federal funds rate to control inflation, and in response, home sales, construction volumes, and home prices in the nation’s hottest markets are all falling, according to John Burns Real Estate Consulting. On top of a buyer slowdown, homeowners are also holding off on listing their properties to preserve affordability.

Roughly 85% of outstanding mortgages are locked in at sub-5% rates, and a recent survey from the New Home Trends Institute found that 64% of existing homeowners with a mortgage are uninterested in purchasing again if the mortgage rate exceeds 5%. In addition to a widespread “lock-in” effect keeping homeowners glued to the sidelines, strict underwriting guidelines on adjustable-rate mortgages (ARMs) are also turning away buyers even though some ARMs are several hundred basis points lower than the 30-year fixed.

In the mid-1990s when 30-year fixed mortgage rates climbed over 9%, ARM usage jumped to 35% of all mortgages. In 1999-2000 as 30-year fixed mortgage rates shot above 8%, ARM usage raged once again to 34% of all mortgages. For comparison, the percentage of homebuyers using ARMs today is just 9%, even as housing affordability resides near its all-time worst and 30-year fixed-rate mortgages have more than doubled in the span of 19 months. As noted by the CEO of KB Home during its Q3-2022 earnings call September 21st: “We have some great and compelling interest rates on adjustable mortgages, where it’s a 10-year fixed. And if I were a buyer, I would take that in a minute.

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