Want lower mortgage payments? 2 scenarios to consider an ARM: Redfin

However, don’t let the historical connotation of ARMs deter you from considering one. There are a few scenarios where an ARM could be quite useful, according to Redfin’s head of economic research, Chen Zhao.

What you should know about ARM today

Unlike a fixed-rate mortgage, which has a constant rate throughout, ARMs can fluctuate based on market conditions after an initial fixed-rate period. Typically, the initial rate on an ARM is lower than that of a fixed rate mortgage. These initial fixed terms can last five, seven or ten years.

ARM underwriting is much stricter than before, adding a guardrail against risky lending practices.

“You actually have to qualify where you can pay for a rate that has adjusted upward,” Zhao said. “So there are fewer people who can qualify for ARM.”

As a result, there are fewer ARMs now than in the early 2000s. Pre-financial crisis, ARMs accounted for about a third of all mortgage originations, but now that number has generally hovered around 10%, according to Zhao.

2 reasons to get an ARM

Zhao believes many people overlook an attractive financing opportunity in the real estate market by not considering an ARM.

“It’s the case that probably more people should consider ARMs because when rates are high, it makes financial sense for a lot of people,” Zhao said.

One group of buyers who should consider ARMs are short-term homeownersaccording to Zhao.

“When you think about ARM versus fixed, the first question you want to ask yourself is, ‘How long do I want to stay in this house?'” Zhao said. “If it’s less than 10 years, especially if it’s less than five years, I think you should really consider an ARM.”

For short-term homeowners, there’s no reason to pay a slightly higher rate to lock in a 30-year fixed mortgage when you can get a cheaper initial rate through an ARM, according to Zhao. They can then sell the home before the fixed rate period ends, avoiding the risk of a potential mortgage rate default.

Second, homebuyers should consider ARMs when rates are high and volatileespecially when rates are expected to fall – as is the case now.

That’s why homebuyers should also ask themselves whether rates are likely to be lower in the future than they are now, according to Zhao.

If the answer is yes, then you should go for an ARM. With the market anticipating a program of interest rate cuts starting in September, mortgage rates are likely to settle at a lower benchmark for the next few years. Zhao estimates that a neutral mortgage rate in the mid-5% range could be reached by the end of 2025. Homeowners can then refinance their mortgages for cheaper in the future. Of course, there is no guarantee that rates will go down in the coming years.

An ARM comes with the risk of higher payments down the road, but in some cases, it offers monthly savings with a low risk of higher payments down the line. For potential homebuyers who answered “yes” to either of the two questions above, an ARM may be right for you.