70% of homeowners with an adjustable-rate mortgage regret it

Adjustable-rate mortgages (ARMs) are a popular option for home buyers, as they typically offer lower interest rates during the introductory period than fixed-rate mortgages. Homeowners often hold onto their ARM until the end of the low-rate period and refinance into a fixed-rate mortgage to avoid the adjustable rate. However, those who got an ARM in the last 10 years are now finding themselves in a bind: they’re nearing the end of their fixed period, and their rates will soon begin to adjust at a time when mortgage rates have settled at their highest levels in decades. As a result, their monthly mortgage payments are set to increase substantially. It’s unsurprising that, according to a new survey from Point, 70% of people who’ve taken out an ARM in the last 10 years say they regret it.

The fall and rise of ARMs

The popularity of ARMs tends to fluctuate with the rise and fall of traditional mortgage rates. When 30-year fixed rates are low, ARMs see a dip in popularity. For example, CoreLogic¹ data shows only 6% of mortgage applications for 30-year loans were for an ARM in January 2021, when rates were at historic lows. ARMs’ popularity rose to 25% in November 2022, as the average fixed mortgage rate hit 6.8%.

ARM popularity versus mortgage rates

As rates rose in 2022, those surveyed reported opting for ARMs with shorter terms, with 47% opting for 3-year term ARMs among new mortgages.

Popularity of ARM Types (2013-2023)

As a result, many homeowners who got an ARM over the past several years (depending on what terms they chose) are likely nearing the end of their introductory period.

ARM holders are set to spend more on their mortgages as rates rise

Homeowners who took out an ARM over the past several years did so when rates were substantially lower than they are today. As a result, they're likely to experience a sharp rise in monthly rates as they enter the adjustable-rate period. The average 5/1 ARM rate in the U.S. was 2.63% in February 2013 and hit a low of 2.37% in December 2021.² If a homeowner plans to refinance their ARM at the end of the fixed period to avoid an increase, they are entering a very different market than when they started their ARM, as fixed-rate mortgages are straddling 7%. While a homeowner in the first adjustable-rate year of their mortgage is unlikely to pay quite that much, the current circumstances are still a far cry from the low rates of 2021.

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Let’s assume a homeowner purchased a median-valued home ($313,000) in January 2019, put 20% down, and took out a 5/1 ARM for $250,400. Average introductory rates for 5/1 ARMs were 3.9% at the time, resulting in a monthly payment of $1,181 through January 2024. If they had taken out a 30-year fixed-rate mortgage, they may have paid a 4.45% average rate and a $1,261 monthly payment instead. Over the five-year fixed period, that 5/1 ARM saved the homeowner $80 monthly, a total of $4,815.

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However, ARM homeowners are now at the end of their introductory rate and have entered a variable rate period.

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During this variable rate period, the interest rate is typically determined by the Secured Overnight Financing Rate (SOFR) – currently 5.3%³ – plus a fixed margin (e.g., 2%). ARMs also include a maximum annual adjustment (e.g., 2%) and a maximum total adjustment (e.g., 6%). Assuming SOFR remains at current levels, the homeowner’s interest rate would increase from 3.9% to 5.9% in 2024 and further to 7.3% in 2025. That means their monthly payment would change from $1,181 in 2023 to $1,637 by 2025, a 39% increase. Compared to having taken out a fixed-rate mortgage 5 years ago, the ARM’s higher monthly payments after the fixed-rate period ends means that this homeowner will have paid more on a cumulative basis by the time they’re seven years into their mortgage⁴, with another 23 years of potentially higher payments to go.

Monthly payment comparison of 30-year fixed and 5/1 ARM

Homeowners face a dilemma: Do they refinance into today’s current interest percentage on a 30-year fixed rate or stay with their variable rate mortgage?

The sunk cost fallacy: why do homeowners keep their ARMs?

Even though most ARM holders regret getting their ARM in the first place, most of them say they plan to keep it. Point’s survey found that an overwhelming majority (82%) of those currently in the introductory fixed-rate period of their ARM still plan to keep it once the fixed-rate period ends. 

Do you plan to keep your ARM after the introductory fixed-rate period ends?

Several conceivable factors might lead a homeowner to retain an ARM beyond the initial period. Changes in their circumstances could affect their ability to secure a new mortgage, or they might be betting on potential future interest rate declines. It's plausible that they don’t see a more advantageous alternative in the current interest rate landscape.

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Refinancing may not save homeowners money in the long run in today's rate environment. For example, if an ARM mortgage holder refinances at current mortgage rates, they’ll save roughly $187 monthly on the mortgage. However, they’ll add five additional years of mortgage payments due to the extension and incur costs associated with refinancing, such as closing costs and other fees. A refinance will ultimately cost homeowners more at the end of the loan’s term, especially if the variable rate declines. 

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Among the few survey respondents who said they plan to exit their ARM, 39% plan to refinance into a fixed-rate mortgage at the end of their ARM’s fixed-rate period. Of those homeowners, 71% said they don’t know if their monthly mortgage payment will increase or decrease once they switch to a fixed rate. 

What do you plan to do at the end of your introductory fixed-rate period?

If homeowners are unclear on whether refinancing to a fixed-rate mortgage will save them money in the long run, they may decide that going through a refinance isn’t worth it and stay the course on their adjustable payment. 

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Other common options for exiting an ARM include paying the mortgage in full or selling the home – which some respondents to Point’s survey said they plan to do. However, these options are not always feasible for those without the cash to pay off their mortgage or those who don’t wish to move. 

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Some survey respondents who expressed regret about getting their ARM said they wished they had a fixed mortgage rate or that the ARM was a strain on their finances. Those who don’t regret their ARM said they are prepared for rate fluctuations, plan to pay off their home or think rates will trend downward this year.

Conclusion

If rates remain at current highs, ARMs may continue to grow in popularity this home shopping season as homeowners look to save money on their mortgage payments in the short term. But while ARM holders stand to reap the benefits of lower monthly payments early on, many report having regrets as their low-interest term ends and the variable rate begins. 

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For those comfortable betting on variable rates declining in the future, an ARM might be a good fit. However, for those who prefer the certainty of a consistent monthly payment, an ARM’s upfront cost savings may not be enough to justify the potential for more expensive rates later in an ARM’s term.