CNN
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Last year, when Jennifer Hernandez received notice that the mortgage payments on her Houston home would increase by about $2,000 a month, she was stunned.
Hernandez refinanced her home loan in 2016 using an adjustable rate mortgage, which has a low introductory rate for a fixed initial period.
Unlike more popular fixed-rate mortgages, ARMs can provide temporary relief for homebuyers who want to avoid paying higher mortgage rates — however, they also come with risk. After the fixed introductory period—typically five, seven, or ten years—the rate on an ARM loan adjusts periodically based on current market conditions.
This means that when mortgage rates rise, many ARM loan holders, like Hernandez, experience the unpleasant shock of significantly higher monthly home payments. For thousands of Americans like Hernandez who took out ARM loans five years ago, before interest rates hit a four-decade high, that shock is coming this year.
Mortgage rates have remained high, fueling one of the most unaffordable housing markets in decades. This led to ARMs gaining traction despite their drawbacks.
According to data from Intercontinental Exchange, a global technology and data provider, 1.7 million homeowners have purchased homes with adjustable-rate mortgages since 2019. Many buyers who purchased 5-year ARMs—one of the most popular offerings— will graduate to much higher monthly payments this year.
The fixed period for these ARMs has already been reset for 328,000 homeowners – and another 102,000 loans will be reset over the next 12 months, according to ICE.
ARM loans gained a bad reputation after the subprime mortgage crisis of 2007 and 2008, as many homebuyers could no longer afford to make their monthly home payments when their rates reset.
While the rate of homebuyers choosing ARMs never returned to pre-2008 levels, the share of homebuyers using ARM loans has doubled over the past four years, according to the Mortgage Bankers Association.
An ARM may make sense for homebuyers comfortable with the risk of rising interest rates or those planning to move or refinance before the fixed rate expires, Lorriane Jones, a loan consultant in Southern California, told CNN.
But when choosing an ARM, it’s essential to keep a close eye on the details, or things can get dicey, fast.
Hernandez, herself a loan officer, had misremembered the terms of her $1.1 million loan: instead of a 10/1 ARM, which has a fixed rate for the first ten years and resets annually after that, Hernandez had received a 7/1 credit.
“They just caught my eye,” she said. “Life gets in the way and you are busy. I’ve been juggling kids and work for the past seven years.”
Last October, Hernandez’s mortgage rate increased 2% to 5.125%, the maximum allowed in the first year of the adjustment, according to the terms of her loan.
Most ARM loans come with an interest rate to prevent costs from spiraling out of control. Hernandez said her ARM is capped at 8.125%, five percentage points above her prime fixed rate.
For Hernandez, it made little sense to refinance the loan while the 30-year fixed mortgage rate remains higher than her new adjusted rate. But next October, she suspects her monthly payments will adjust more.
“I got it working, but now I’m going to have to figure out how to get it working again this October,” she said. “It’s stressful to worry about it.”
Andrew Marquis, a loan officer in Lexington, Massachusetts, said he has seen a dramatic increase in ARM loan applications recently. Homebuyers increasingly believe the Federal Reserve will lower interest rates in the coming years, giving these buyers time to refinance their loans before their fixed ARM period expires, said he. The Fed does not directly set mortgage rates, but its actions affect them. This year, the Federal Reserve has signaled that it may cut its key interest rate once.
“I would say for the large loans we’re doing, maybe 40% of the loans are doing ARMs,” Marquis said, referring to loan amounts over $766,000.
Marquis said getting an ARM loan can be worthwhile for those with a higher risk appetite.
“If people can save half a percent on a seven-year ARM versus a 30-year fixed, they’re saving hundreds of dollars a month,” he said.
Interest rates can be unpredictable. Hernandez said she saved money in the first seven years of her loan, but if she could make up her mind, she likely wouldn’t have chosen an adjustable-rate mortgage in 2016.
“This increase in payments has not felt good,” she said. “I’m just praying that when my October fix comes, the rates will have dropped a bit.”