Although only 2% of homebuyers opted for an adjustable-rate mortgage (ARM) in 2016,1 there’s evidence that ARMs are proving more popular with house-hunting millennials.2
Unlike a fixed-rate mortgage, whose interest rate remains the same for the life of the loan, an ARM’s rate is guaranteed for only a set period—say, five or seven years—before rising or falling in tandem with prevailing interest rates.
It’s that initial rate that can make ARMs so attractive to millennials and other potentially cash-strapped purchasers. “ARMs typically start out at a lower interest rate—and thus a lower monthly payment—than their fixed-rate counterparts,” says Tony Sachs, vice president of lending products and strategy at Charles Schwab Bank.
Indeed, in October 2017 the average rate on a 30-year fixed-rate mortgage was 3.80%, compared with 3.31% for a 5/1 ARM3 (that is, a loan whose interest rate is fixed for the first five years and adjusted once a year thereafter for the life of the loan). For a $350,000 loan, that means a savings of almost $100 a month, or about $6,000 over the initial five-year term.
“ARMs can make a lot of sense for home buyers who plan to upgrade in a few years,” Tony says.
The bottom line: Opting for ARMs can offer lower initial monthly payments in the near term, while their fixed-rate counterparts provide more stability over the long haul.
1Sean Becketti, “Why America’s Homebuyers & Communities Rely on the 30-Year Fixed-Rate Mortgage,” Freddie Mac, 04/10/2017.
2Robyn A. Friedman, “Mortgages Undergo an Attitude Adjustment,” The Wall Street Journal, 07/05/2017.
3Claes Bell, “Mortgage Rates Trend Higher for Monday,” bankrate.com, 10/02/2017.