Mortgage rates jump above 4% — prompting borrowers to return to a staple of the housing bubble

It is becoming more and more expensive to buy a home: not only are home prices rising in double digits every year, but mortgage rates have risen and this week have exceeded 4% for the first time since May 2019. This is pushing more buyers to hire adjustable housing. -type mortgages: one of the financial culprits of the 2006 housing crisis.

The proportion of mortgages that are adjustable rate mortgages (ARMs) doubled to 10% in January, from a 10-year low of 4% in January 2021, according to CoreLogic data. MRAs offer a low initial rate over a period of years, usually between 3 and 10 years, and then the rate is adjusted after that, usually annually, based on a fluctuating reference rate plus an additional margin, such as 2%.

The reason for the resurgence of interest in ARMs is clear: these loans offer a much lower initial rate than a conventional 30-year mortgage. For example, the average initial rate of an ARM of 5/1 year (an ARM that is set for 5 years and then restarted each year) is 3.19%, almost one percentage point lower than the current rate of the ARM. 4.16% for a 30-year mortgage, according to Freddie Mac. But of course, once this initial 5-year rate expires, buyers can receive a higher rate, such as 5.19% instead of 3.19%.

This initial rate can represent a significant savings for home buyers who are facing record home prices. The average quoted property prices have increased by almost 27% from the start of the pandemic until February, reaching a high of nearly $ 400,000, according to data from Realtor.com.

Looking at the math, this means that a buyer who reduces by $ 10,000 on a $ 400,000 home and finances the rest with a 30-year loan at current rates will have a monthly payment of $ 1,752. But the initial rate for a 5/1 year ARM would be $ 1,555, a savings of about $ 2,400 a year.

“When you see prices rising more and more, having that purchasing power gives buyers more options to look at a home,” said Brian Rugg, credit director at loanDepot, a company that offers consumer loans, including mortgages. “When you consider ARM versus flat rates, it gives you more flexibility.”

The resurgence of interest in ARMs may raise questions about whether the real estate market is echoing some of the trends of 2006, when home prices rose as buyers bought property and lenders opened up. their portfolios to offer loans. But financial experts say there are some differences between the current pandemic housing boom and 2006, such as the banks’ stricter lending standards.

The jump in mortgage rates is keeping many buyers out of the market, the National Association of Realtors (NAR) said on Thursday. Since the beginning of the year, some 6.3 million homes have been evicted from the home buying market, including 2 million millennial buyers, NAR said. NAR said it expects rates to rise further, ending the year at 4.3%.

Bad fame

Lending standards are stricter today than during the 2006 housing bubble, Rugg said. More than a decade ago, in the housing process, some lenders handed out so-called “liar loans,” or mortgages that required little or no income documentation. Today, banks require buyers to verify their income to qualify for a loan.

Adjustable rate mortgages had a bad name in the real estate bubble because they were pending some buyers who could not qualify for a conventional mortgage. Because the initial “teaser” rate meant lower monthly payments to buyers, lenders were more willing to push for loans, according to Brookings Institution research.

This became problematic, however, when the real estate market crashed and ARMs were reset at higher rates than those buyers could handle.

But today, banks are checking to make sure borrowers can manage adjustable-rate mortgages, including if their income can absorb a higher rate once the initial period expires, experts say. Although the proportion of ARMs is rising, it is still well below where it was in the mid-2000s, when more than half of new mortgages were adjustable rate loans.

And there are also limits to how far an ARM can move higher, minimizing the impact on borrowers.

“Banks will make sure you meet the requirements for this, and there are limits to rate changes,” said Melissa Cohn, William Raveis Mortgage’s regional vice president. “It’s a completely different market.”

ARMs can be useful for home buyers who do not plan to stay home for more than a handful of years, Rugg of loanDepot noted.

“It’s ideal for people for whom it’s not their home forever,” Rugg said. “As a homeowner, you get a lower rate to generate income and eventually they can move and move to a bigger home. So for me, it’s ideal.”

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