Many homebuyers jumped at the chance to take out an adjustable rate mortgage (ARM) when interest rates began spiking in early 2022.
ARMs are attractive when rates rise because they start with a lower “teaser” rate that varies periodically after the first three to 10 years, with subsequent adjustments reflecting current market conditions. Buyers can land a bargain on their initial rate or trade up to a bit more house than they could afford with a traditional fixed mortgage. The median borrowing amount for ARMs is more than $40,000 larger compared to regular mortgages, data from the St. Louis branch of the Federal Reserve shows.
Some homeowners with 30-year ARMs thought they were getting a discount on the American dream.
It’s not turning out that way.
ARM adjustments can be upward or downward, depending on the market, and with interest rates still high, many homeowners now owe meaningfully more in monthly payments for their houses, condos or apartments. The resets are slicing into homeowners’ personal balance sheets just as the Trump administration’s global tariffs start to seep into consumer prices, prompting more ARM holders to turn to buy now, pay later and other alternative budgeting tools to manage their monthly expenses. Mortgage payments typically eat up around 30% of a household’s income, the St. Louis Fed branch says. The more spent on your home, the less for essential and discretionary purchases.
Advertisement: Scroll to Continue
It all means that the price tag of the American dream now comes with fine print: Home ownership can push you into spending all your monthly income as soon as it comes in the door. Consumers can find themselves in that paycheck-to-paycheck reality either by necessity — they don’t earn enough income for non-essential purchases — or by choice — they have good income and meet their monthly basics, but opt to spend what’s left over on nice-to-haves. Either way, ARM resets make the affordability of daily life more difficult.
A recent PYMNTS Intelligence report found that nearly four in 10 ARM holders have recently delayed or canceled a major purchase, versus 31% of fixed rate mortgage holders. Some 42% have cut back on non-essential spending, more than 37% of fixed-rate holders. Nearly one in two (46%) are using credit cards to cover basic purchases, versus 40% of those with fixed-rate loans. The signal: ARMs can put consumers in a slow-motion financial squeeze — and it’s starting to tighten.
SOFR, So Bad
Homebuyers who take out ARMs are betting that higher, fixed rates on traditional 30-year mortgages are a temporary blip, that lower rates on those mainstay loans will last, or that that they’ll sell their house before the first adjustment sets in. For the first two scenarios, the wager is that when an ARM’s initial rate resets, the broader market will either have rebalanced to lower rates or have consistently been there. That’s not happening.
Take a five-year ARM, the most common type of adjustable mortgage, with a rate of 2.91% in August 2020. It’s now adjusting according to the index it’s tied to, the most common being the secured overnight financing rate, or SOFR. That index’s rate is now 4.39%. A homeowner with a $400,000 mortgage will see their monthly payment rise this month to $2,001 from $1,667, a $334 increase, according to Zillow’s mortgage calculator. The figures don’t include property taxes or insurance.
Some people with 3/1 ARMs are faring worse. Historical data on those mortgages is scarce — Freddie Mac and the Fed stopped tracking 3/1 rates in 2022 due to insufficient data from lenders — but the loans typically have rates below those of 5/1 ARMs.
Assume our same homeowner as above took out a 3/1 ARM at 2.5% in January 2022. That seemed smart at the time — it was on the eve of the Fed’s first of 11 consecutive interest rates hikes in March, intended to combat the steepest inflation in four decades following a flood of post-COVID money into the economy. But last January, the loan adjusted to 4.32%. The homeowner’s monthly payments shot up to $1,984 from $1,580, over $400 more. The average rate on a 30-year fixed rate mortgage was 6.72% as of end-July, making refinancing an ARM expensive. The industry likes to say, “marry the house, date the rate,” but the honeymoon for now is over.
Worse may be yet to come. ARMs come with rate increase “caps” — a typical 5/1 limits the first rate adjustment to five percentage points above the initial rate, later adjustments to two percentage points above the previous rate, and a lifetime cap of 5% on the initial rate.
But the sticker shock over time can be severe. For example, a $400,000 mortgage at 3% is $1,686 a month, not including insurance and taxes, mortgagecalculator.org shows. At the lifetime cap of 8%, it’s $2,935 — over $1,200 more. The real inflation threat may not be in groceries or gas — it’s in mortgages that haven’t adjusted yet.
ARMs Race
By November 2022, as the Fed continued to raise rates following its first increase in March, 12% of all mortgages were ARMs, compared to just over 3% a year prior, data from the Washington, D.C.-based think tank Urban Institute shows.
By one estimate, the ARMs race has since pulled back, and the mortgages now account for just over 8% of all residential loans applications, equal to one in 12 borrowers. Data on ARMs is notoriously variable; if there are now just over 51 million residential mortgages of all types outstanding, according to U.S. federal housing agency data, perhaps four million American have ARMs.
The Urban Institute says today’s ARMs are nothing like those pre-dating the 2007-08 financial crisis and that they helped open homeownership to more people amid booming property prices. In June 2022, the rate on a fixed 30-year home loan spiked to an average 5.81%, topping out at 7.79% by November 2023, Freddie Mac shows a 5/1 ARM in November 2023 hovered around a more affordable 7%. ARMs are popular with younger, higher-income households that can more easily absorb a rate increase, the St. Louis Fed branch says. But that doesn’t necessarily mean a homeowner’s spending patterns can stay the same.
Income Squeeze
PYMNTS Intelligence data shows that living paycheck to paycheck is not just the purview of lower-income consumers. It also encompasses millions of middle- and upper-income Americans.
If ARMS were initially a financial life raft that allows homebuyers to get in on the American dream for less, that raft now looks less sea-worthy.
Relief isn’t in sight any time soon. Fed Chair Jerome Powell, whom President Donald Trump is pressuring to cut interest rates, said on Wednesday (July 30) that tariffs “have begun to show through more clearly to prices of some goods, but their overall effects on economic activity and inflation remain to be seen.” Inflation — and its impact on rates — could be “short-lived” or its effects “more persistent,” he added — meaning that ARM holders might not find joy the next time their mortgages adjust.
Pocketbook pressure is coming from other sides as well.
The Trump administration restarted collections on student loans in May; defaults on the loans could slash consumer spending by $63 billion by dinging credit scores, closing off access to new credit and reducing disposable income through wage garnishments, Bloomberg reported.
Meanwhile, the consumer price increases many economists have been looking out for after companies stockpiled goods in anticipation of tariffs are starting to show up. Consumer goods giant Procter & Gamble, the maker of products like Tide detergent and Pampers, said July 29 it would raise prices “in the single digits” on a quarter of its goods. Nearly half of U.S. consumers expect price increases to be double the rate of inflation, currently 2.7% — a sentiment that economists know can become self-fulfilling.
To find extra cash, Americans are pulling money out of their 401(k)s in record numbers, investment giant Vanguard said in June, with 4.8% taking a hardship distribution to plug financial emergencies last year, more than double the rate during the pandemic. But non-hardship withdrawals have also risen to 4.5% of account holders, up from 4% last year and during the height of the pandemic in 2021.
Read more:
The Adjustable Rate Reckoning: How Home Ownership is Pushing Millions Paycheck to Paycheck
Rising Mortgage Costs Push Affluent Families to the Financial Edge
Consumers Say They Want Budgeting But Aren’t Using Them
