According to the Mortgage Bankers Association, buyers are increasingly moving toward ARM loans for the first time since the pandemic.
In fact, last week ARM loans accounted for 8.5% of all mortgage applications.
For those either too young to remember or too old and forgot, an ARM, or adjustable-rate mortgage, gives you a fixed rate for an initial period, commonly three, five, seven, or ten years, and then the rate resets on a schedule after that, usually annually. The rate you get at each reset is typically somewhere in the 2 to 3.5 percentage point range. Caps limit how much the rate can move at the first adjustment, at each subsequent adjustment, and over the life of the loan, but caps limit the damage, they don’t prevent it.
ARMs can be appealing. Current Rates are approximately one full point lower than those for a fixed-rate mortgage. After all, the thinking goes, you can always refinance when the rates rise, right?
Maybe. Maybe not. ARMS offer the lower rate as an incentive. The tradeoff is risk.
It makes sense to think that prices always go up, and we may see a booming economy five or ten years from now that sends duplex values soaring, making it easy to refinance.
Besides, rent increases should also be substantial enough to cover any increase in mortgage payments, right? Of course, that assumption ignores the fact that the property’s other expenses are likely to increase over that time. This will affect cash flow and investment viability. Given recent jumps in property taxes and insurance premiums, those numbers are unlikely to be inconsequential.
If you’re considering an adjustable rate mortgage, you may want to do a little math before you move forward. Simply take the property’s current rent roll, hold it flat and calculate your payment at the maximum rate the loan’s caps allow at the first adjustment. Not at what you think it might be, but the maximum. If that number doesn’t work with today’s rents and vacancy rates, you’re simply betting that the market bails you out.
None of this means an ARM is automatically the wrong call. It can be a reasonable tool if your holding period is genuinely short and you’ve stress-tested that assumption. This approach can also be useful if you’re disciplined and intend to apply the initial payments to rapidly reduce principal. It can also make sense for an experienced owner who’s comfortable actively managing rate risk the way they’d manage any other business risk, with eyes open and a real contingency plan.
What it shouldn’t be is the default choice because the introductory rate makes today’s numbers look better.
Before you sign, get specific answers, in writing, on what index the loan is tied to, what the margin is, what the caps are at first adjustment, subsequent adjustments, and over the life of the loan. Ask if there’s a prepayment penalty if you refinance early, and what your worst-case payment would actually be in dollars, not just in percentage points.
A loan officer quoting you a rate should be able to answer all of that without hesitation. If they can’t, or if the answer is buried in fine print, or you have to ask twice, that’s information too.