Are Adjustable Rate Mortgages a Lifeline for Lower Rates? Or the Most Dangerous Thing You Could Do?

If, like me, you check mortgage interest rates like an expectant parent checks their wife’s contractions, you doubtless will have analyzed every type of loan product in an attempt to inch the currently high rates down. 

Famed financial guru Suze Orman recently appeared on CNN extolling the virtues of an adjustable rate mortgage (ARM). But to many American homebuyers, mentioning an ARM is like the Ghost of Christmas Past returning to haunt us once more: Weren’t ARMs partly to blame for the 2008 financial crash? 

ARMs were derided in 2008 because many Americans got into financial trouble. Once their interest rates adjusted upward after three, five, or seven years, borrowers could not refinance down to a lower rate and fell into foreclosure. So why is Orman—whose monetary advice tends to be conservative—suggesting we go ice skating on a financial frozen lake?

Live to Fight Another Day

Such has been the accelerated rise in interest rates that many would-be buyers and current investors have found themselves gasping for air to afford a new home, investment, or refinance. This is particularly true if you have a high-interest rate bridge loan and were expecting a refinance to provide you with a soft landing of a new 4% rate. In this instance, an ARM could be the difference between sinking or swimming. 

So living to fight another day is better than not fighting at all. Most experts agree that rates will eventually come down, so staying afloat until that happens, in theory, makes sense.

House Prices Always Go Up

“If you can afford to buy, you always buy,” said Orman, shrugging off the news that with higher rates, it’s now cheaper to rent than buy. Her logic? House prices always rise, and getting into the game as soon as possible is always beneficial in the long run. 

Orman’s thinking is straightforward for homebuyers looking for a personal residence with no interest in investing. For investors, however, renting a personal residence while buying an investment is the way to go, not purely for the tax benefits (in the current market, cash flow is likely to be compromised), but because when rates do eventually come down, investors will come flooding back, and prices will increase. 

“I’ve always been an advocate of ARMs, especially for investors, when the market justifies it,” Caeli Ridge, president of Ridge Lending Group, who specializes in investor financing, told BiggerPockets. “The average shelf life of a mortgage on a rental property is five years. So, I would 100% recommend an investor to take the ARM if it is 0.5% to 1% lower. The chances of the mortgage being refinanced or for a lower rate or a cash-out refinance is high, not to mention the possibility of a 1031 exchange via a sale.” 

Ridge stresses caution when considering an ARM for a personal residence, saying that unless you can find a rate markedly lower than a 30-year fixed, it’s not always worth it.

According to CNBC, “The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($766,550 or less) increased to 7.29% last week from 7.24% the previous week, with points decreasing to 0.65 from 0.66 (including the origination fee) for loans with a 20% down payment. Meanwhile, the average contract interest rate for 5/1 ARMs fell to 6.60% from 6.64%.” ARMs need to be refinanced 

Is Waiting for Rates to Drop Good Advice?

Waiting for interest rates to drop is a gamble. If rates fall and prices increase, investors must calculate how much they can gain by playing the waiting game. 

Different parts of the country will not appreciate at the same rate. Areas that have experienced dramatic price increases (Austin, Texas notably being one) and other Sunbelt areas where there has been increased inventory due to new construction have seen prices drop. 

Until existing inventory is filled and overheated prices return to normal, it’s unlikely prices will increase much, even with lower rates, so waiting could make more sense—especially for prospective buyers who currently have low rates or whose rent is lower than a mortgage payment would be. 

Things Prospective Buyers Can Do to Lower Rates

You are not entirely beholden to the machinations of the Federal Reserve. There are certain things you do now to help lower your rate if you simply have to buy: 

• Improve your credit score: A proven track record of being financially responsible is the best way to be assured of increasing your credit score and getting the lowest rate.
• Buy down points: Buying down points means paying money upfront to buy down percentage points on your interest rate. Again, you would need to make a calculation based on the time you intend to keep the property and the likelihood interest rates will decrease.
• Get an FHA-backed loan: Loans backed by the government, such as Federal Housing Administration (FHA)-backed and Veterans Affairs (VA)-backed loans, tend to have lower rates than conventional or jumbo loans because they come with the federal government’s protection.
• Make a larger down payment: If you have assets in the stock market or elsewhere that are not appreciating much, it might be worth liquidating them to put a larger down payment on a home, which will save you money on your monthly mortgage payment.
• Take out a shorter-term loan: Shorter-term loans (such as 15-year mortgages) come with lower interest rates but higher monthly payments. However, they can save you thousands in the long term. Alternatively, you can simply make extra payments toward your principal to pay down the loan quicker, giving you the flexibility to switch back to a 30-year loan if necessary.

Final Thoughts

There is a lot of one-size-fits-all information floating around online. While much of it—such as Suze Orman’s advice—makes for good sound bites and clickbait, working out what’s best for you requires a deep dive with a lot of specificity. 

Knowing how long you plan to own a home, the cost of refinancing, and all the loan options available to you will help you decide. Adjustable rate mortgages are good in theory for certain situations, but now would not appear to be one of them, especially for personal residences. Talking to a reputable lender that offers a wide variety of loan products to compare and contrast your options, especially if you are an investor, is a good first step.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.