ARM borrowers may regret their loans but aren't giving them up: study

A majority of adjustable-rate mortgage borrowers rue their decision to take out the loans, but even more plan to stick with them, according to new research.

The rise of interest rates since 2022 to more than two-decade highs drove the sentiment, as ARM borrowers find a substantially different financial environment today versus the last 10 years, the report from home equity investment platform Point said. Approximately 70% of ARM holders, including homeowners in both the introductory and variable-rate phase, said they now regret their choice. 

The sharp increase in monthly payments is hitting many households already dealing with higher costs from elevated inflation over the past two years, as well as their other debts. "When you add on top of that, a sharp increase in mortgage payments – which, for the vast majority of homeowners, is going to be by far their largest monthly expense -- it can definitely put a big strain on their finances," said Shoji Ueki, head of marketing and analytics at Point.

Point's research, conducted in January, surveyed borrowers who took out adjustable-rate mortgages between 2013 and 2023. The popularity of ARMs historically grows in higher-rate environments, as buyers aim to lower initial monthly payments. 

At the start of the 10-year period in February 2013, the average 5/1 ARM rate was 2.63% and fell to a low of 2.37% in December 2021, according to Freddie Mac. In early 2019, introductory rates for those loans averaged 3.9%. But as those borrowers exit fixed terms this year, they may see them rise two percentage points to 5.9%, with the rate tied to the current benchmark Secured Overnight Financing Rate. The annual rate of increase is capped at 2% and 6% overall for the duration of the loan.

If the SOFR benchmark remains near current levels, their rate would jump up to 7.3% in 2025. For an approximately $250,000 loan, monthly mortgage payments would leap 39% from from $1,181 in 2023 to $1,637 by 2025. Seven years into their loan, borrowers will have paid more cumulatively than they would have had they chosen a 30-year fixed mortgage, with a rate of 4.45%, Point determined. 

But despite the significant ramp-up in potential monthly payments over the next 24 months, an even larger 82% share of respondents said they planned to keep the ARMs they had, while 10% said they were uncertain. Although their reasons vary, borrowers may have few choices if circumstances have changed. 

While refinancing into a 30-year fixed mortgage is an option, it might not be available to homeowners who already missed payments, Ueki noted.   

"[If] you're delinquent and as a result, your credit score suffered, it can be tough to find other financing options," he said. 

Refinancing at current rate levels may limit the financial benefit over the full life of the mortgage once transaction costs and extra years are added in as well.  

Others may choose to keep their ARMs and make regular payments in expectation rates will fall over time. "That's, of course, a guessing game as well."   

The rapid pace at which mortgage rates rose in 2022 and 2023 caught many off guard, even among those who fully understood the risks, Ueki said. Between late 2021 and late 2023, the average 30-year interest rate more than doubled from near 3% and currently sits at 6.88%. 

"We heard a lot of survey responses that definitely got into sentiment that they did not realize that their monthly payments could increase to this degree." 

At the same time, there appears to be a lack of detailed knowledge of refinance terms, even among the borrowers who intend to take one once their introductory rate ends. Among that particular subset of borrowers, 71% were not certain their monthly payments would increase or decrease when transitioned to a fixed rate.   

While variable-rate mortgages helped create conditions leading up to the Great Financial Crisis, underwriting standards have tightened since. The rate of home equity accrual in the last three years might be providing some assistance to borrowers, allowing homeowners to apply for second liens to help with payments if they qualify, according to Ueki. In the fourth quarter of 2023, Corelogic determined American homeowners had gained $1.3 trillion in equity annually. 

Over the past two years, just as interest rates began their surge, loans with 3-year fixed introductory periods were the most popular type of ARM, with a 47% share relative to total volume. Five-year introductory rates accounted for 31%, with 7-to-10 year terms making up 22%.  

But in the peak years of 2020 and 2021, 5-year fixed terms were predominant at 41%, followed by the 3-year at 36%. ARMs with 7-to-10 year terms garnered 23% of volume.