In this article, we look at the different attributes of households holding adjustable-rate mortgages (ARMs) and fixed-rate mortgages in the 2019 Survey of Consumer Finances (SCF). Despite the current release of the 2022 SCF, we have chosen to use the 2019 SCF due to the fact that it does not consist of any of the modifications and characteristics connected with the COVID-19 pandemic, which are beyond the scope of this post. Motivated by the present high mortgage rates, which can make outstanding ARMs more expensive when their rates reset, we have an interest in discovering out which borrowers are exposed to these higher rates. We found that households holding ARMs were more youthful and made greater incomes and that their initial mortgage sizes were bigger and had larger 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 should be paid on top of the primary loan quantity. Adjustable-rate mortgages have rates that generally track a benchmark rate that shows existing economic conditions and is more closely affected by the interest rate set by the Federal Reserve.Although rates for ARMs are developed to be adjustable, rates on ARMs are typically repaired for an initial period, normally five or seven years, after which the rate is generally reset annually or two times a year. Additionally, ARMs may have restrictions on just how much the rates can alter and a general cap on the rate.

For example, throughout the Fed's current tightening 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 implies the rate is free to adjust annually after being fixed for the very first five years. rose from 4.1% to 7.6% during the same duration. To put this in viewpoint, consider a home that obtained $200,000 utilizing a 5/1 ARM in October 2018. This family made regular monthly payments of $964 during the first five years of the mortgage. The regular monthly payments then increased to $1,412 in October 2023, when the rate changed.

By contrast, a fixed-rate mortgage would not experience a boost in payments in 2023, having secured the lower rate for the life of the loan. Given this threat, fixed-rate mortgages usually have greater initial rates. Had the household taken out the exact same $200,000 in a fixed-rate mortgage at 4.8%, the payment would have been $1,053 in October 2018, however then it would have remained continuous in 2023.

Mortgage payments represent about 30% of home earnings, and as we showed in an earlier Economic Synopses essay, exceptional mortgages represent about 70% of home liabilities, so this boost in regular monthly payments represents a substantial additional concern on families.

Identifying Households with ARMs

To understand which households are most impacted by modifications in rates of interest through ARMs, we calculated the share of homes with mortgages that hold either ARMs or fixed-rate mortgages throughout the income distribution and compared some basic qualities of these families and their mortgages, including the rates, the preliminary size of the mortgages, and the staying balance.

The figure below shows the share of mortgages by income decile. Overall, ARMs represent a minority of overall mortgages.

Distribution of Kinds Of Mortgages by Income Decile

SOURCES: 2019 Survey of Consumer Finance and authors' estimations.

NOTE: Households are divided into earnings deciles, in which the first decile represents those with the most affordable income and the 10th represents those with the greatest earnings.

As shown 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 with 6.5% in the bottom decile (the very first). While our numbers are based upon the 2019 SCF, this Wall Street Journal article reported that ARM applications were just over 7% of all mortgage applications in 2023

One possible description for why holding ARMs is more focused in higher-income deciles is that households with greater income are more able to soak up the threat of higher payments when interest rates increase. In exchange, these homes can benefit right away from the lower initial rates that ARMs tend to have. On the other hand, homes with lower income might not have the ability to manage their mortgage if rates get used to a considerably higher level and thus choose the predictability of fixed-rate mortgages, especially because they have the alternative to refinance at a lower rate if rates drop.

The table below shows some other general characteristics of ARMs and their debtors versus those of fixed-rate mortgages and their debtors.

ARMs tend to have lower interest rates. However, the median preliminary borrowing amount is over $40,000 larger for ARMs, and the typical remaining balance that families still require to pay is also larger. The typical family income amongst ARM holders is likewise 50% more than the average income of those holding fixed-rate mortgages. This is constant with the figure above, in which the share of ARMs increases amongst higher-income homes. The median age of ARM holders is likewise 18 years lower.

ARMs Appear to Skew towards Younger, Higher-Income Households

In sum, ARMs seem to be more popular with younger, higher income homes with larger mortgages, and ARM ownership relative to fixed-rate ownership almost tripled from the bottom to top income decile. Given their age and income, these kinds of households might be better geared up to weather the risk of fluctuating rates while their proportionally bigger mortgages gain from the lower introductory rates.

Notes

1. Despite the current release of the 2022 SCF, we have actually chosen to use the 2019 SCF since it does not consist of any of the changes and characteristics associated with the COVID-19 pandemic, which are beyond the scope of this post.
2. Although rates for ARMs are created to be adjustable, rates on ARMs are frequently fixed for an introductory period, typically five or seven years, after which the rate is generally reset yearly or two times a year. Additionally, ARMs might have restrictions on just how much the rates can alter and an overall cap on the rate.