In this article, we look at the various attributes of homes holding adjustable-rate mortgages (ARMs) and fixed-rate mortgages in the 2019 Survey of Consumer Finances (SCF). Despite the recent release of the 2022 SCF, we have selected to use the 2019 SCF because it does not consist of any of the changes and dynamics connected with the COVID-19 pandemic, which are beyond the scope of this post. Motivated by the present high mortgage rates, which can make outstanding ARMs more pricey when their rates reset, we are interested in discovering which customers are exposed to these greater rates. We discovered that households holding ARMs were younger and made greater earnings and that their initial mortgage sizes were bigger and had larger exceptional balances compared to those holding fixed-rate mortgages.

Characteristics of ARMs

About 40% of U.S. households have mortgages, of which 92% have actually repaired rates and the remaining 8% have adjustable rates. Fixed-rate mortgages have a set rate of interest for the life of the loan, which need to be paid on top of the primary loan quantity. Adjustable-rate mortgages have rates that generally track a benchmark rate that reflects present economic conditions and is more closely impacted by the rate of interest set by the Federal Reserve.Although rates for ARMs are designed to be adjustable, rates on ARMs are often fixed for an introductory duration, usually five or seven years, after which the rate is generally reset every year or twice a year. Additionally, ARMs might have limitations on just how much the rates can change and a total cap on the rate.

For instance, throughout the Fed's present tightening up period, the 30-year mortgage rate increased from 4.8% in October 2018 to 7.6% in October 2023, while the rate on the 5/1 ARMThis means the rate is complimentary to adjust every year after being fixed for the first five years. rose from 4.1% to 7.6% during the very same period. To put this in perspective, think about a home that obtained $200,000 utilizing a 5/1 ARM in October 2018. This household made regular monthly payments of $964 throughout the first five years of the mortgage. The month-to-month payments then increased to $1,412 in October 2023, when the rate adjusted.

By contrast, a fixed-rate mortgage would not experience an increase in payments in 2023, having secured the lower rate for the life of the loan. Given this danger, fixed-rate mortgages typically have higher initial rates. Had the household secured the very same $200,000 in a fixed-rate mortgage at 4.8%, the payment would have been $1,053 in October 2018, however then it would have stayed continuous in 2023.

Mortgage payments account for about 30% of home earnings, and as we displayed in an earlier Economic Synopses essay, exceptional mortgages represent about 70% of home liabilities, so this boost in regular monthly payments represents a significant extra burden on households.

Identifying Households with ARMs

To comprehend which families are most affected by modifications in rates of interest through ARMs, we determined the share of families with mortgages that hold either ARMs or fixed-rate mortgages throughout the income circulation and compared some basic qualities of these families and their mortgages, including the rates, the preliminary size of the mortgages, and the staying balance.

The figure below programs the share of mortgages by earnings decile. Overall, ARMs represent a minority of total mortgages.

Distribution of Kinds Of Mortgages by Income Decile

SOURCES: 2019 Survey of Consumer Finance and authors' estimations.

NOTE: Households are divided into income deciles, in which the very first decile represents those with the most affordable income and the 10th represents those with the greatest earnings.

As shown in the figure, the share of mortgages that have adjustable rates is usually greater amongst families in the higher-income deciles: 18.8% in the top decile (the 10th) compared with 6.5% in the bottom decile (the first). While our numbers are based upon the 2019 SCF, this Wall Street Journal article reported that ARM applications were simply over 7% of all mortgage applications in 2023

One possible description for why holding ARMs is more concentrated in higher-income deciles is that households with greater earnings are more able to soak up the threat of higher payments when rate of interest increase. In exchange, these households can benefit right away from the lower initial rates that ARMs tend to have. On the other hand, homes with lower earnings might not be able to afford their mortgage if rates get used to a considerably higher level and hence prefer the predictability of fixed-rate mortgages, specifically since they have the option to re-finance at a lower rate if rates drop.

The table listed below reveals some other basic attributes of ARMs and their debtors versus those of fixed-rate mortgages and their customers.

ARMs tend to have lower interest rates. However, the mean initial borrowing quantity is over $40,000 bigger for ARMs, and the mean remaining balance that homes still need to pay is also bigger. The average household income amongst ARM holders is likewise 50% more than the median income of those holding fixed-rate mortgages. This is constant with the figure above, in which the share of ARMs increases among higher-income homes. The mean age of ARM holders is also 18 years lower.

ARMs Appear to Skew toward Younger, Higher-Income Households

In sum, ARMs appear to be more popular with more youthful, greater earnings households with bigger mortgages, and ARM ownership relative to fixed-rate ownership almost tripled from the bottom to top income decile. Given their age and income, these types of homes may be better equipped to weather the risk of fluctuating rates while their proportionally bigger mortgages take advantage of the lower initial rates.

Notes

1. Despite the current release of the 2022 SCF, we have selected to utilize the 2019 SCF due to the fact that it does not include any of the changes and characteristics connected with the COVID-19 pandemic, which are beyond the scope of this post.
2. Although rates for ARMs are designed to be adjustable, rates on ARMs are often repaired for an introductory duration, typically five or seven years, after which the rate is normally reset every year or two times a year. Additionally, ARMs might have constraints on how much the rates can change and a total cap on the rate.