Adjustable-rate mortgages can lower payments as interest rates soar

This week’s 30-year fixed rate jumped to 5.78%, the largest weekly surge in 35 years.

By Jeff Lazerson | jlazerson@mortgagegrader.com | MortgageGrader.com | June 20, 2022

Jeff and Kim Noviello got outbid in their first two offers for the Mission Viejo home they fell in love with at the front door. Two other buyers had higher offers.

The third time was the charm, however, as the previous sets of buyers fell out. Escrow closes next week.

Mortgage rates and home prices continued to ascend during their five-month effort to find home. Last month, instead of locking their $950,000 loan balance on a 30-year fixed at 5.25%, they opted for a 10-year adjustable-rate mortgage fixed at a 4% rate (30-year term). At 4%, their principal and interest payment is $4,535, compared with a $5,246 payment at 5.25%.

That’s a $711 monthly savings, or nearly a 15%. That’s one way to beat inflation.

The 4% rate kept their payments within their monthly budget. They plan to transition to a fixed rate down the road when rates drop.

“Everyone I know is in the mortgage biz, and they were telling me not to do an ARM,” said Jeff Noviello, a client of mine.

But the fixed-rate alternative has gotten way too costly.

Mortgage rates exploded this week. The average Freddie Mac rate climbed 55 basis points from last week’s 5.23% rate, landing at 5.78%. That’s the highest 30-year rate since Nov. 28, 2008, and the fifth biggest one-week jump in records dating back to 1971. (The biggest was 140 basis points in March 1980.)

No doubt homebuyers are pressing and stressing about mortgage qualifying and being able to personally afford the monthly house payments for a home with the features and amenities they want.

Mortgage payments jumped 35% since the start of the year, when 30-year rates averaged 3.22%. The principal and interest payment for a $647,200 mortgage (the maximum conforming loan amount) was $2,806, compared with $3,789 this week. That’s a $983 payment shock.

“As home prices and mortgage rates increase, more homebuyers are being forced to change their expectations to something they can afford — like one less bedroom,” said Ted Tozer, a fellow at the Urban Institute’s Housing Finance Policy Center and former Ginnie Mae president under the Obama administration. “People are scared of ARMs, but an ARM is a decent alternative to a fixed rate. I don’t have to take as much off my requirements list.”

Another transitory home loan is a 40-year fixed or adjustable mortgage with an interest-only payment for the first 10-years. Rates broadly range from about 4.5% to 7%, depending on the borrower’s income and credit qualifications and down payment.

What about waiting to buy for home-price drops, or even a crash? After all, right now the Federal Reserve’s number-one job is snuffing out our 40-year-high inflation rate. Even the Fed admits it’s not going to be easy to slow inflation and avoid choking off the economy into a recession.

On Wednesday, June 15, the Fed raised short-term interest rates by three-quarters of a point, the biggest rate boost since 1994. This means the prime rate is now 4.75%. And most home equity lines-of-credit are tied to prime. Another big Fed rate hike of perhaps one-half to three-quarters of a point is expected in July.

Even though it’s still a sellers’ market, for-sale inventory is rising, according to Steven Thomas, chief economist at Reports on Housing. As of June 9, there were 32% more homes on the market in Southern California compared with a year earlier. Market time, or days on market before going into escrow, is now 49 days, compared with 27 days a year ago.

“As (mortgage) rates go up, the buyer pool shrinks,” said Thomas. “During the Great Recession, there were 120,000 homes on the market in Southern California and 23,000 today. Muted demand against muted inventory.”

Most experts I spoke with believe home prices will largely remain stable. But not Michael Pento, president and founder of Pento Portfolio Strategies.

“Even though mortgage underwriting is better, and there is a shortage of single-family homes, real estate prices will drop 20-25% over the next year,” said Pento. “The bull market has ended. Stocks are down, crypto is down. The Blackstones of the world are going to have to start selling rentals.”

Freddie Mac rate news: The 30-year fixed rate averaged 5.78%, 55 basis points higher than last week. The 15-year fixed rate averaged 4.81%, 43 basis points higher than last week. The 5-year ARM averaged 4.33%, 21 basis points higher than last week.

The Mortgage Bankers Association reported a 6.6% increase in mortgage application volume from the previous week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $647,200 loan, last year’s payment was a crushing $1,085 less than this week’s payment of $3,789.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages without points: A 30-year FHA and a 15-year conventional at 5.25%, a 30-year conventional at 5.875%, a 15-year conventional high-balance ($647,201 to $970,800) at 5.875%, a 30-year conventional high-balance at 6.125% and a 30-year fixed jumbo at 5.25%.

Eye-catcher loan of the week: A 30-year jumbo interest-only purchase mortgage, locked for the first seven years at 4.875% without points.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.