Fannie Mae: Here’s why ARMs work for some borrowers

More borrowers jump aboard

Adjustable-rate mortgages used to be one of the hottest products on the market in 2005, making up nearly 40% of purchase money mortgages. Now almost nine years later, ARMs sit roughly around 5%.

So why the change?

Mortgage rates started to trend higher at the end of last year, leading to a 5% drop in January existing home sales and the fifth decline over the last sixth months, Orawin Velz, director of economic and strategic research with Fannie Mae, said.  

“In the past, surging mortgage rates led to a sharp rise in the use of ARMs,” Velz said. “However, in today's mortgage market, borrowers have fewer options for affordable ARM products as they face more stringent underwriting standards.”

Between rising mortgage rates and falling affordability, ARMs are beginning to look more appealing to the industry since they help boost purchasing power by lowering the monthly mortgage payment.

Currently, Fannie Mae noted that the most appealing ARM is the 5/1 ARM, which has the potential to enhance housing affordability by about 15% on average.   

As a result, from the end of 2012 to the end of 2013, the ARM share of purchase applications more than doubled.

This is in addition to a hybrid ARM which allow borrowers to get a bigger loan for the same monthly payment during the initial beginning period.

But despite all these factors, the market still remains significantly below peak levels in 2005.

“It will likely remain subdued going forward, given tighter lending standards for ARMs and the new Qualified Mortgage rule that took effect in January of this year – which curtailed availability of the riskier ARMs, including interest-only products and those with balloon payments,” Velz said.

“The limited ability of potential homebuyers to switch to ARMs in the face of rising rates and declining affordability in the current environment supports the Economic and Strategic Research Group’s cautious outlook of the existing home market this year,” she added. 

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