In this post, we take a look at the various characteristics of homes 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 actually chosen to utilize the 2019 SCF since it does not include any of the modifications and dynamics associated with the COVID-19 pandemic, which are beyond the scope of this article. Motivated by the existing high mortgage rates, which can make exceptional ARMs more expensive when their rates reset, we are interested in finding out which customers are exposed to these greater rates. We discovered that families holding ARMs were more youthful and made higher incomes which their initial mortgage sizes were larger and had bigger impressive balances compared to those holding fixed-rate mortgages.

Characteristics of ARMs

About 40% of U.S. households have mortgages, of which 92% have fixed rates and the staying 8% have adjustable rates. Fixed-rate mortgages have a set interest rate for the life of the loan, which need to be paid on top of the principal loan quantity. Adjustable-rate mortgages have rates that typically track a benchmark rate that reflects current economic conditions and is more closely impacted by the interest rate set by the Federal Reserve.Although rates for ARMs are created to be adjustable, rates on ARMs are typically fixed for an initial duration, usually five or 7 years, after which the rate is typically reset annually or twice a year. Additionally, ARMs may have restrictions on just how much the rates can change and a total cap on the rate.

For example, throughout the Fed's present 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 adjust yearly after being fixed for the first five years. rose from 4.1% to 7.6% throughout the exact same duration. To put this in point of view, think about a home that $200,000 utilizing a 5/1 ARM in October 2018. This household made regular monthly payments of $964 during the first 5 years of the mortgage. The monthly payments then increased to $1,412 in October 2023, when the rate changed.

By contrast, a fixed-rate mortgage would not experience an increase in payments in 2023, having locked in the lower rate for the life of the loan. Given this threat, fixed-rate mortgages typically have higher initial rates. Had the household taken out the 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 stayed consistent in 2023.

Mortgage payments account for about 30% of home income, and as we displayed in an earlier Economic Synopses essay, exceptional mortgages represent about 70% of home liabilities, so this boost in month-to-month payments represents a substantial additional burden on families.

Identifying Households with ARMs

To comprehend which households are most affected by modifications in rate of interest through ARMs, we determined the share of families with mortgages that hold either ARMs or fixed-rate mortgages throughout the earnings distribution and compared some basic attributes of these families and their mortgages, including the rates, the initial 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 Types of Mortgages by Income Decile
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SOURCES: 2019 Survey of Consumer Finance and authors' calculations.

NOTE: Households are divided into income deciles, in which the first decile represents those with the least expensive earnings and the 10th represents those with the highest income.

As displayed in the figure, the share of mortgages that have adjustable rates is generally greater among families in the higher-income deciles: 18.8% in the leading decile (the 10th) compared with 6.5% in the bottom decile (the very first). While our numbers are based on the 2019 SCF, this Wall Street Journal post reported that ARM applications were just over 7% of all mortgage applications in 2023

One possible explanation for why holding ARMs is more concentrated in higher-income deciles is that households with higher income are more able to take in the risk of greater payments when interest rates increase. In exchange, these homes can benefit instantly from the lower introductory rates that ARMs tend to have. On the other hand, families with lower earnings might not be able to manage their mortgage if rates adapt to a considerably higher level and hence prefer the predictability of fixed-rate mortgages, especially since they have the alternative to refinance at a lower rate if rates drop.

The table listed below shows some other basic attributes of ARMs and their debtors versus those of fixed-rate mortgages and their debtors.

ARMs tend to have lower rate of interest. However, the typical initial loaning quantity is over $40,000 larger for ARMs, and the median staying balance that households still require to pay is likewise larger. The median family income among ARM holders is likewise 50% more than the median earnings of those holding fixed-rate mortgages. This follows the figure above, in which the share of ARMs increases among higher-income families. The mean age of ARM holders is also 18 years lower.

ARMs Appear to Skew towards Younger, Higher-Income Households
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In sum, ARMs seem to be more popular with younger, higher income households with larger mortgages, and ARM ownership relative to fixed-rate ownership nearly tripled from the bottom to top income decile. Given their age and income, these kinds of families may be better equipped to weather the danger of fluctuating rates while their proportionally larger mortgages gain from the lower initial rates.

Notes

1. Despite the recent release of the 2022 SCF, we have selected to utilize the 2019 SCF due to the fact that it does not include any of the changes and dynamics related to the COVID-19 pandemic, which are beyond the scope of this blog site post.

1. Although rates for ARMs are designed to be adjustable, rates on ARMs are typically repaired 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 limitations on just how much the rates can alter and a general cap on the rate.