Demand for adjustable-rate mortgages hits 14-year high

Demand for mortgages is on the rise due to what analysts say is an increase in listings on the market and fear that interest rates will continue climbing higher. However, buyers are increasingly turning to adjustable-rate mortgages, or ARMs, as opposed to standard fixed-rate mortgages.

ARMs have an advantage in that they offer lower initial rates for a period of several years.

The Mortgage Bankers Association said mortgage applications to buy a new home rose by 5% in the last week compared to the week before. Demand is still down 8% from a year ago, however that annual drop has been shrinking in recent weeks. .

The increased demand for mortgage applications comes despite the average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($647,200 or less) rising to 5.53% from 5.36%, with points rising to 0.73 from 0.63 (including the origination fee) for loans with a 20% down payment.

The higher interest rates are believed to be the main factor pushing consumers towards ARMs instead. The rate on a five-year ARM was 4.47% last week.

“Despite a slow start to this year’s spring home buying season, prospective buyers are showing some resiliency to higher rates. Purchase activity has now increased for two straight weeks,” said Joel Kan, an MBA economist, in a release. “More borrowers continue to utilize ARMs to combat higher rates. The share of ARMs increased to 11% of overall loans and to 19% by dollar volume.”

At the beginning of the year, when rates were still close to record lows, ARMs accounted for just 3% of all purchase applications. At 11%, it is at its highest share since March 2008.

With ARMs, homebuyers can obtain lower rates for a fixed term of five, seven or 10 years, after which the rate will change depending on market conditions. ARMs are fully underwritten, the same as fixed-rate mortgages, and also require a down payment. That’s different from the days preceding the Great Recession, when poorly underwritten interest-only ARMs with shorter teaser periods helped create the housing crash in the late 2000s.

Interestingly, while new homebuyers are showing greater interest, existing homeowners are less inclined to refinance. Refinance applications fell 2% week on week, and are down 72% from a year ago. Analysts say that’s because very few buyers these days can actually benefit from refinancing at today’s higher interest rates.