Adjustable Rates Still Low as Fixed 30-Year Rate Hits 20-Month High

Although 30-year mortgage rates are at their highest point since May 2020, homebuyers still have plenty of opportunity to lock in a mortgage rate well below 3%.

The Freddie Mac Primary Mortgage Market Survey* provides a weekly snapshot of average mortgages rates. On Thursday, the average 5/1 adjustable rate mortgage (ARM) was below 2.5% while the 30-year fixed rate mortgage (FRM) was above 3.2%.

With a 5/1 ARM, the initial mortgage rate is locked in for 5 years before it adjusts to the market rate each year after.

The 5/1 ARM ran nearly step-for-step with the more well-known 30-year FRM from March 2020 to February 2021. In February 2021 both rates increased nearly to 3% before taking off in separate directions.

The 30-year FRM danced around 3% for the latter half of 2021 and began a steady climb in September when the Federal Reserve announced it would taper the economic stimulus spending that had been keeping mortgage rates artificially low. In the latest survey (pictured above), the average 30-year rate jumped above 3.2% after yesterday’s release of Federal Open Market Committee’s December meeting minutes revealed conversations about tapering faster than previously expected.

Concerns over a quick taper, and the multiple interest rate hikes to follow, caused a steep increase in both the 30- and 15-year FRMs this week. The 5/1 ARM, on the other hand, was unaffected and has been on a downward trajectory since splitting from the 30-year FRM nearly a year ago.

The last time we covered the FRM-ARM split, the 5/1-ARM was 0.55 percentage points lower than the 30-year FRM. That gap has increased to 0.79 points and the average 5/1 ARM is now lower than the 15-year FRM for the first time since 2019. That means some homebuyers may be able to get a lower adjustable rate on a 30-year mortgage than a fixed rate on a 15-year mortgage, and avoid the hefty monthly payment required on the shorter term loan.

One potential reason for dropping 5/1 ARM rates is that mortgage lenders foresee interest rates rising over the next few years. They can lock in borrowers now at sub-3% rates with a safe bet that rates will be substantially higher when they adjust after 5 years.

Even so, 5/1 ARMs – which are currently at the third lowest point in 15 years – may make sense for many homebuyers.

According to ATTOM Data Solutions, the average homeownership tenure for sellers in the first quarter of 2021 was less than 8 years. And prior to the pandemic, the average tenure is historically well below that.

There is the risk of a 5/1 ARM adjusting to a higher mortgage rate. But the average borrower will be more than halfway through their tenure after having an exceptionally low rate for half a decade.

Plus, ARM loans come with caps on how high the rate can rise. For instance a 5/1 ARM at 2.5% with a lifetime cap of 5% can never rise above 7.5% (2.5% start rate plus 5% lifetime cap). ARMs come with a built-in insurance policy against 1980s-style rates.

Ultra-low rates and protection in the future may be especially attractive to first-time homebuyers looking for starter homes – or anyone who relocates frequently. With a mortgage rate near 2.5%, they can allocate more money toward purchase price and less toward interest, thus expanding their homebuying options.

And more options are just what first-time homebuyers need after a year of record rent and home price increases. The wiggle-room from a 5/1 ARM could be just what they need to break into homeownership and start building equity to use toward their next home.

While the 30-year mortgage rate will dominate headlines as it (predictably) continues to rise in 2022, adjustable rates are quietly offering the best deal for homebuyers that plan on a short stay.

*All mentions of mortgage rates are based on Freddie Mac's PMMS survey and may not be currently available. Apply here to check your rate.