[This article is the third in our three-part series on adjustable-rate mortgages (ARMs). We’re diving into what ARMs are, how they work, and the situations in which a borrower might be interested in pursuing one. To access the rest of the series, click here.]
We recently sat down with Lori Sullivan, one of our Sr. Credit Policy Managers, to discuss how ARMs work and when an ARM might be the right choice for your borrowers.
Q: Can you explain why we’re seeing an increase in ARM loans?
A: It really boils down to rates. Until this year, ARMs haven’t been in demand because 30-year-fixed rates have near historic lows for quite some time. Borrowers who got those low fixed rates want to keep them. But that started to change after the Fed began raising rates to curb inflation. Because the initial rate on most ARMs is significantly lower than most 30-year-fixed rates, a borrower can get into a home with a lower payment—at least for the initial term, whether that’s three, five, seven or 10 years.
Q: How much are ARM volumes increasing?
A: We aren’t seeing massive volumes, at least not yet. According to the Mortgage Bankers Association’s numbers, in July 2022, ARMs were roughly 10% of all purchase originations, which is up from about 5% last year. That’s still much lower than before the 2008 housing crisis, when ARMs comprised about 30% of all loans.
However, demand for ARM loans is likely to increase, especially as the housing market begins to cool off.
Q: What are the benefits of selecting an ARM vs. a fixed rate in today’s market?
A: The key benefit is the lower initial payment. For example, a borrower with a loan amount of $400,000 who gets a 30-year-fixed rate at 6.75% will have a monthly principal and interest payment of $2,600. In the event that same borrower chose a 5/6 ARM at 6.00%, the payment comes down to just $2,400 for the first five years. If they then decide to sell their home within that five-year period, the 5/6 ARM works out quite well.
If your borrower is using an ARM to buy their first home, that initial lower payment will come in handy considering all the additional expenses and maintenance that can come with owning a home.
Q: What should borrowers consider when getting an ARM loan?
A: If your borrower only plans to be in the home for three to five years, or they feel good about their future income, an ARM can be a great choice.
For example, let’s say you have a borrower who is a recent college graduate who has solid credit and is currently working as a paid intern. At some point in the not-too-distant future, your borrower expects to receive a full-time job offer at a significantly higher salary. They may be a strong candidate for an ARM, because they’ll feel more secure about being able to afford a higher payment.
When you counsel your borrowers about ARMs, you really should tell them to be prepared for the worst-case rate scenario, even though there are caps on ARMs. While your borrowers must be qualified for a higher rate than the note rate, they may believe their rate will never actually get as high as the maximum rate—but it could. It’s important to have that candid discussion with them.
Q: Who might not be a good candidate for an ARM?
A: In short, borrowers who don’t like uncertainty. Some borrowers just don’t like not knowing what will happen to their rate in the future.
Borrowers who have trouble managing their cash flow could have trouble with an ARM, too. The ideal ARM borrower is someone who is disciplined enough with their money to be able to handle rate increases, should they decide to keep their home for more than several years.
Q: How are today’s ARM products different than in the past?
A: It’s really night and day. As you hear more about ARMs, you should keep in mind that what your borrowers are getting isn’t what it used to be.
Before the 2008 housing crisis, borrowers could qualify at the lower, initial rate for an ARM, thinking that they would “graduate” into a higher payment. Of course, when ARM rates began adjusting, many of these borrowers experienced payment shock and found themselves way over their heads.
All of that is gone. Today, it’s about making sure they can afford the maximum payment according to all the typical factors we look at, including credit score and DTI. We want to make sure that if a borrower defaults, the reason won’t be related to their interest rate changing.
Q: What is the value that MI provides in a high interest, ARM-heavy mortgage environment?
A: The value is really the same for any borrower with less than a 20% down payment. It’s all about helping your borrowers into a home and offsetting the risk to the lender.
We consider any loan that has a fixed rate for five years or more to be a fixed-rate loan as far as MI is concerned. This may not be the case with other MI providers. Also, the MI premium rate stays the same—it doesn’t adjust with the interest rate. In our view, it’s all about keeping your borrower’s payment down and not penalizing them because they happen to get an ARM.
Q: Where can I go for more information or for help with ARMs?
A: We recommend ensuring that every borrower considering an ARM carefully reads the CFPB’s booklet on ARMs. The latest version presents all kinds of scenarios and walks through each of them. Freddie Mac and Fannie Mae also have information about ARMs in their selling guides.
Because going the extra mile for our customers is in our DNA, we provide a wealth of resources on ARMs, including fliers describing ARM basics, how they work, and the protection Enact MI can provide for these loans. We offer a training course on ARMs, too.
If you need to secure MI for a borrower’s ARM loan, Enact offers coverage at very competitive premium rates. Just contact your Enact Sales Rep for more info. They’ll be happy to help get your transactions across the finish line and beyond.
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