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In this article, we take a look at the different 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 selected to use the 2019 SCF due to the fact that it does not include any of the changes and dynamics connected with the COVID-19 pandemic, which are beyond the scope of this article. Motivated by the current high mortgage rates, which can make outstanding ARMs more costly when their rates reset, we have an interest in discovering which borrowers are exposed to these greater rates. We discovered that homes holding ARMs were more youthful and made higher and that their initial mortgage sizes were larger and had larger outstanding balances compared with those holding fixed-rate mortgages.

Characteristics of ARMs
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About 40% of U.S. households 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 need to be paid on top of the primary loan amount. Adjustable-rate mortgages have rates that typically track a benchmark rate that reflects present financial conditions and is more closely affected by the rate of interest set by the Federal Reserve.Although rates for ARMs are developed to be adjustable, rates on ARMs are frequently repaired for an introductory duration, generally five or 7 years, after which the rate is typically reset annually or two times a year. Additionally, ARMs may have constraints on just how much the rates can alter and a total cap on the rate.

For instance, throughout the Fed's existing 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 change each year after being fixed for the first five years. rose from 4.1% to 7.6% throughout the very same duration. To put this in viewpoint, think about a home that borrowed $200,000 using a 5/1 ARM in October 2018. This household made monthly payments of $964 throughout the very first 5 years of the mortgage. The monthly payments then increased to $1,412 in October 2023, when the rate adjusted.

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 risk, fixed-rate mortgages normally have higher introductory rates. Had the household secured the exact 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 consistent in 2023.

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

Identifying Households with ARMs

To understand which families are most affected by modifications in interest rates through ARMs, we determined the share of families with mortgages that hold either ARMs or fixed-rate mortgages across the earnings distribution and compared some basic qualities of these households and their mortgages, including the rates, the preliminary size of the mortgages, and the remaining balance.
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The figure listed below programs the share of mortgages by income decile. Overall, ARMs represent a minority of overall mortgages.

Distribution of Types of Mortgages by Income Decile

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

NOTE: Households are divided into income deciles, in which the 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 normally greater among households in the higher-income deciles: 18.8% in the leading decile (the 10th) compared with 6.5% in the bottom decile (the first). While our numbers are based upon the 2019 SCF, this Wall Street Journal article 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 earnings are more able to soak up the threat of higher payments when rates of interest increase. In exchange, these households can benefit instantly from the lower introductory rates that ARMs tend to have. On the other hand, households with lower income may not be able to manage their mortgage if rates adapt to a considerably higher level and thus choose the predictability of fixed-rate mortgages, specifically because they have the choice to re-finance at a lower rate if rates drop.

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

ARMs tend to have lower interest rates. However, the typical preliminary loaning amount is over $40,000 larger for ARMs, and the mean staying balance that homes still need to pay is also larger. The mean family income amongst ARM holders is likewise 50% more than the median income of those holding fixed-rate mortgages. This follows the figure above, in which the share of ARMs increases among 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 younger, higher earnings households with bigger mortgages, and ARM ownership relative to fixed-rate ownership nearly tripled from the bottom to top earnings decile. Given their age and income, these kinds of families might be much better equipped to weather the risk of varying rates while their proportionally larger mortgages take advantage of the lower initial rates.

Notes

1. Despite the recent release of the 2022 SCF, we have actually picked to utilize the 2019 SCF because it does not include any of the changes and characteristics related to the COVID-19 pandemic, which are beyond the scope of this article. 2. Although rates for ARMs are developed to be adjustable, rates on ARMs are typically fixed for an initial duration, usually five or seven years, after which the rate is usually reset yearly or twice a year. Additionally, ARMs may have constraints on how much the rates can change and a total cap on the rate.