How much faith do you have in the Federal Reserve continuing to cut rates? It’s not often we believe what our government tells us, but this time, there is a fair amount of faith among borrowers. In the meantime, while we’re waiting for the Feds to make their decisions, buyers are looking at loans that may be a little risky but will also be less expensive.
Adjustable-Rate Mortgages (ARMs) were popular when rates were high but fell out of favor when rates started to fall. ARMs are initially cheaper, but they reset their rate usually after three to 10 years. This will increase the monthly payment for the borrowers, who need to make sure they will have the income to adjust to the higher rate.
As of Nov. 6, the average rate for a 30-year fixed-rate mortgage was 6.22%. The average rate during this time for an ARM was 5.55% for a 5/1 ARM; “5” represents the length of the initial fixed rate period in years and “1” represents the frequency of the rate adjustment.
Buyers are anxious for affordable monthly payments as well as qualifying for homes in this market, which have increased more than 50% since 2019. They also don’t want to wait any longer to get into a home, therefore, the adjustable-rate mortgage has more appeal than ever.
Mortgage rates generally tend to track government borrowing costs, but ARMs are more in line with short-term rates while fixed-rate mortgages are more in line with 10-year Treasury yields. This is why when the Feds lower their rate, it does not always translate into a lower mortgage rate immediately. Confusing, yes, but if you work with a competent mortgage broker or lender, it will be easily explained.
Because of tighter lending standards, ARMS are less risky today than back in 2004 when buyers were looking at their initial fixed-rate only, without considering if they could afford the higher rate. When the rates adjusted, many found they couldn’t afford the extra monthly payment and were facing foreclosure. Today, lenders vet buyers more carefully to determine if they can afford the larger monthly payment when the mortgage resets at a higher rate.
Adjustable-rate mortgages work well for buyers who plan to sell within the initial fixed-rate period or are confident that their financial situation will cover an increase in monthly payments. They are also rolling the dice that rates will go down during the initial period, and they could come out ahead when the adjustment hits.
Don’t forget the importance of your credit score and how it affects your mortgage rate. A credit score will determine whether you qualify for a mortgage and the interest rate you’ll be offered. The higher the credit score, the lower the interest rate you’ll qualify for. A score of 620 is a “fair” rating, not great. However, a credit score of 740 or higher will typically be considered to be in very good standing and can usually qualify for better rates.
There is a belief in the homebuying community that mortgage rates will continue to go down over the next several years. If this turns out to be true, we could be looking at a more advantageous real estate market going forward, and a lot of happy homebuyers.
