Homebuyers

Homebuyers May Want an Adjustable-Rate Mortgage This Fall for This Big, Money-Saving Reason

Mortgage rates have been on the decline lately, much to the delight of homebuyers and homeowners. The recent fall in rates has been driven by the Federal Reserve's decision to lower its rates. 

Homebuyers waiting for mortgage rates to dramatically decline may be in for a longer wait—unless they choose an adjustable-rate mortgage.

That’s because mortgage rates are separate from the Federal Funds rate. So, interest rates for 30-year, fixed-rate loans may remain elevated.

However, buyers may notice more movement in adjustable-rate mortgages, often called ARMs. Because ARMs are more closely tied to the Fed’s short-term rate decisions, rates for these loans could ease a bit further if the Fed brings rates down.  

For certain buyers, that change could open new ways to keep their monthly payments manageable. Here’s what home hunters need to know about choosing an ARM.

What a Fed cut could (and couldn’t) do for mortgage rates

A single Fed rate cut may not move the needle below 6% on 30-year fixed mortgages.

ARMs, however, are linked more directly to short-term benchmarks such as the Secured Overnight Financing Rate (SOFR). That means they tend to respond in real-time when the Fed acts.

Analysts say if the Fed trims rates more than once this year, ARM rates could edge closer to 5.5% by the end of 2025, according to Barrons.

“With shorter term rates likely to come down in the future combined with longer term rates likely to stay elevated, those are ripe conditions for…more attractive ARM rates versus fixed rates,” said Jason Obradovich, chief investment officer at New American Funding.

That difference in rates, compared with fixed loans that may remain above 6%, could be enough to shift the math for some buyers.

How adjustable-rate mortgages work today

ARMs today are not the same as the fast-resetting products that fueled problems during the housing crash of the 2000s.

Most modern ARMs are structured as 5/6, 7/6, or 10/6 loans. That means your interest rate is fixed for five, seven, or 10 years. Then it adjusts every six months.

Additionally, safeguards are built in. Caps (how much the rate can change at reset) limit how much the rate can rise both at the first adjustment and over the life of the loan.

In practice, that means borrowers start out with several stable years at a lower rate. Then by the time your rate adjusts, you may be ready to refinance or move.

How much money could you save with an adjustable-rate mortgage?

Homebuyers are often able to save money with ARMs, when the interest rates are lower than for fixed-rate loans.

As of the first week of September, 30-year fixed mortgage rates are holding in the mid-6.5% range, according to Mortgage News Daily. The rate for a 7/6 ARM was closer to 5.8%.

On a $400,000 loan, that gap could work out to about $170 less per month during the fixed period or more than $2,000 a year.

If the Fed lowers its benchmark rate by a quarter-point by the end of the year, ARM rates may slip a little more, trimming payments further.

That’s why ARMs could become a more appealing option for some households this fall.

Who should consider an adjustable-rate mortgage?

Fixed-rate mortgages still dominate the market, with most borrowers choosing them for the stability they provide. That’s because they don’t need to worry about rates going up or down and changing the size of their monthly payments.

However, for buyers trying to stretch their budget, or simply wanting more flexibility in the early years, an ARM may offer an alternative path.

An ARM isn’t the right choice for everyone, but it can make sense in certain situations. Consider one if:

• You know your timeline. If you’re planning to sell the home within five to seven years, a 7/6 ARM may align well with that time horizon.
• You’re open to refinancing. If mortgage rates trend lower over the next few years, you may be able to switch into a 30-year fixed before your ARM resets.
• You want flexibility today. Lower monthly payments may help you afford the home you want while providing more breathing room in your budget.

Even so, the term ARM still gives some buyers pause.

That’s why it’s essential to run the numbers carefully. A lender can estimate what your future payments could look like so you understand what future payments may look like.

How to shop for the right mortgage for you

If you’re visiting open houses this fall, ask lenders to provide you with quotes for both a 30-year fixed-rate and an ARM on the same day. That way, you can compare apples to apples on loan size, fees, and points.

Look beyond the headline rate and focus on the margin (the set amount added to the index once the ARM adjusts to determine your rate) and the caps on how high the rate can go.

And most importantly: match the mortgage to your life. If you don’t expect to stay in your home for the long haul, then an ARM may be worth considering.