Adjustable-rate mortgages often have lower interest rates than their fixed-rate counterparts, at least initially. Why are they overlooked?
It could have much to do with the home loans receiving a bad rap during the housing meltdown, so borrowers are likely still dodging them, says Dave Jacobin, president of 1st Mariner Mortgage in Baltimore.
"There were all kinds of crazy adjustable-rate mortgage offerings out there," Jacobin says. Some of the loans were 10-year ARMs, which adjust annually after the first 10 years. Other loans adjusted after just the 1st or 2nd year.
The guidelines for ARMs during the bubble "allowed a lot of people to get into loans that probably shouldn't have been in those loans and really didn't have a chance for success from the get-go," Jacobin says.
'Pick-a-pay' loans cause trouble
Another adjustable product offered pre-crisis was the payment option ARM, or "pick-a-pay" loan, in which borrowers had a large or small monthly payment of their choosing such as:
- An amount that's part of an amortization schedule for a 15- or 30-year term.
- An interest-only payment.
- A minimum payment.
Borrowers who chose to pay just the minimum found themselves experiencing negative amortization, which is when the amount owed increases -- even after the borrower makes a payment.
"Everybody banked on the fact that housing values were going to continue to increase, but we all know that that wasn't the case," Jacobin says. "When housing values are decreasing at a rapid pace and your balance on your mortgage that you owe is increasing, that's a recipe for disaster -- and that's what happened."
ARM market share diminishes
In 2005, ARMs commanded 38.5% of the mortgage market, according to an analysis by the Federal Reserve Bank of New York. A decade later, Ellie Mae reports that ARMs account for only 5.3% of all mortgages originated during September 2015.
Uncertainty over the interest rate environment could also be contributing to borrowers' aversion to ARMs. More people see increasing risk in the marketplace and are choosing to stay away from ARMs as a result, according to a RealtyTrac report.
When will ARMs make a comeback?
Two things would have to happen for adjustable-rate mortgages to make a comeback: Mortgage rates would have to significantly increase and homes would have to become less affordable.