In this post, we look at the various qualities of families 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 picked to use the 2019 SCF since it does not consist of any of the changes and characteristics related to the COVID-19 pandemic, which are beyond the scope of this blog site post. Motivated by the present high mortgage rates, which can make outstanding ARMs more pricey when their rates reset, we have an interest in discovering which debtors are exposed to these higher rates. We found that homes holding ARMs were younger and earned higher earnings which their preliminary mortgage sizes were bigger and had bigger impressive balances compared to those holding fixed-rate mortgages.

Characteristics of ARMs

About 40% of U.S. families have mortgages, of which 92% have 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 must be paid on top of the primary loan amount. Adjustable-rate mortgages have rates that typically track a benchmark rate that reflects existing economic conditions and is more carefully affected by the rates of interest set by the Federal Reserve.Although rates for ARMs are created to be adjustable, rates on ARMs are often fixed for an initial period, usually five or seven years, after which the rate is usually reset each year or two times a year. Additionally, ARMs may have constraints on just how much the rates can change and an overall cap on the rate.

For example, throughout the Fed's existing tightening up duration, 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 suggests the rate is totally free to change each year after being fixed for the first five years. increased from 4.1% to 7.6% during the exact same duration. To put this in point of view, think about a home that borrowed $200,000 utilizing a 5/1 ARM in October 2018. This home made regular monthly payments of $964 throughout the very first five years of the mortgage. The regular monthly 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 introductory rates. Had the family gotten the same $200,000 in a fixed-rate mortgage at 4.8%, the payment would have been $1,053 in October 2018, but then it would have stayed continuous in 2023.

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

Identifying Households with ARMs

To understand which homes are most impacted by changes in rates of interest through ARMs, we determined the share of homes with mortgages that hold either ARMs or fixed-rate mortgages across the income distribution and compared some general attributes of these homes and their mortgages, including the rates, the preliminary size of the mortgages, and the staying balance.

The figure listed 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' computations.

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 highest earnings.

As displayed in the figure, the share of mortgages that have adjustable rates is typically higher amongst families in the higher-income deciles: 18.8% in the top decile (the 10th) compared to 6.5% in the bottom decile (the first). While our numbers are based on the 2019 SCF, this Wall Street Journal post 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 homes with greater income are more able to take in the risk of greater payments when rates of interest increase. In exchange, these homes can benefit right away from the lower introductory rates that ARMs tend to have. On the other hand, families with lower earnings might not have the ability to manage their mortgage if rates get used to a considerably greater level and thus prefer the predictability of fixed-rate mortgages, especially because they have the choice to refinance 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 median preliminary loaning quantity is over $40,000 larger for ARMs, and the mean staying balance that families still need to pay is likewise bigger. The mean family income among ARM holders is also 50% more than the typical earnings of those holding fixed-rate mortgages. This is constant with the figure above, in which the share of ARMs increases amongst higher-income families. The typical age of ARM holders is likewise 18 years lower.

ARMs Appear to Skew toward Younger, Higher-Income Households

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

Notes

1. Despite the current release of the 2022 SCF, we have actually selected to utilize the 2019 SCF because it does not consist of any of the changes and characteristics related to the COVID-19 pandemic, which are beyond the scope of this blog site post. 2. Although rates for ARMs are designed to be adjustable, rates on ARMs are often repaired for an initial duration, typically 5 or seven years, after which the rate is typically reset annually or two times a year. Additionally, ARMs might have restrictions on just how much the rates can change and a total cap on the rate.