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Adjustable-Rate Mortgages Are Making A Comeback
Adjustable-rate mortgages are regaining popularity as a way to combat high-interest rates, despite the fact that this type of mortgage contributed to the housing crash in 2008.
Published 07/13/2022
Over the last few years, the country has seen some historically low mortgage rates. When more traditional mortgages like 15-year and 30-year fixed loans had extraordinarily low rates, there was no real reason to look into different types of home loans. But now that mortgage rates are going through the roof, home buyers have to look for alternative options to make homeownership obtainable. Thus, the adjustable-rate mortgage (ARM) has been making a comeback.
So, what exactly is an adjustable-rate mortgage? An adjustable-rate mortgage, also known as a variable-rate mortgage, is pretty much exactly what it sounds like. ARMs come with an interest rate that adjusts over time based on the market. Typically, ARMs start out with lower interest than fixed-rate mortgages, which makes them an appealing choice in today’s real estate market. However, home buyers need to make sure they understand what they are getting into because that initial low-interest rate may increase with time.
You may also remember ARMs as one of the factors that led to the housing crash in 2008. During the housing boom in the mid-2000s, approximately 35% of all mortgages were adjustable rate. ARMs are less predictable than fixed-rate mortgages, and many homeowners were not prepared for an increase in their interest rates. This meant that when interest rates reset, there were a lot of homeowners unable to make their new monthly mortgage payments, forcing many homeowners into foreclosure. But this didn’t stop many predatory lenders from luring in buyers with ARMs and the initial low-interest rate that made homeownership seem affordable in the time leading up to the crash.
Despite their bad reputation, ARMs aren’t inherently bad. It just worked out that a large share of borrowers had this type of loan and caused problems when everything imploded in the mid-2000s. Even so, the demand for ARMs is surging. To illustrate, more people used ARMs in May of 2022 than at any other time since the housing market crashed.
That said, experts are saying we don’t need to worry about ARMs contributing to another housing crash in the future. In the wake of the 2008 housing crash and the Great Recession, new legislation and practices have been put into place to make sure it doesn’t happen again. Notably, the Dodd-Frank Act prevents excessive financial risk-taking by requiring buyers to show proof of adequate income before being approved for a home loan, which wasn’t previously required. Prior to this legislation, consumers could simply state their income when applying for a home loan without backing it up with evidence. Additionally, the Dodd-Frank Act provided new common-sense protections for American families to prevent mortgage companies and pay-day lenders from exploiting consumers.
In general, the financial sectors are in a much healthier place than they were back in 2007 and 2008. Tighter lending standards and a whole new set of underwriting guidelines help ensure that approved homeowners will be able to make their monthly payments and won’t end up in foreclosure. It’s much harder today than it was in the past to get approved for a home loan you can’t afford. In fact, lenders are actively taking steps to make sure that doesn’t happen.
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