Key highlights from this report:
- Historically, ARM loans offered lower rates than 30-year fixed mortgages.
- But a new and noteworthy mortgage rate trend has emerged in 2020.
- 30-year loans are now competitive (and sometimes cheaper) than ARMs.
- The two charts below put these recent U.S. trends into perspective.
“If you choose a 5-year adjustable-rate mortgage (ARM) loan instead of the more popular 30-year fixed home loan, you could secure a lower rate and save money in the short term.”
For years, that was the conventional wisdom that led many borrowers to choose short-term ARM loans over the more stable 30-year fixed.
And there was some truth to that notion.
As you’ll soon see, adjustable mortgage products like the 5-year ARM typically offered lower interest rates than the more widely used 30-year fixed-rate mortgage. With a 30-year home loan, you would basically pay a premium in exchange for long-term stability and predictability.
But that was then, and this is now.
Things Have Changed, on the Interest Rate Front
As of fall 2020, the average rate for a 30-year fixed mortgage loan in the U.S. is comparable with (and sometimes lower than) the average rate for a 5-year ARM loan. You can see this clearly in the mortgage rate trends chart below.
The reasons for this are somewhat complicated.
Basically, investors don’t want to buy ARM loans right now. Mortgage rates in the U.S. are hovering at historically low levels, as of fall 2020. So there’s a good chance the interest rate assigned to a short-term ARM loan will rise when the introductory period ends. This would encourage the borrower to refinance, meaning the original lender or servicer would lose their business after only a few years.
In essence, the mortgage industry (and the investors who buy the loans they generate) are discouraging borrowers away from ARM loans and toward the longer-term mortgage products, like the 30-year fixed.
The bottom line here — and really the only thing a borrower needs to know — is that the standard 30-year fixed home loan is even more appealing today, due to the rate trends we’ve seen in recent months. And speaking of those trends…
Chart: Mortgage Rate Trends Through Fall 2020
The chart below is based on the long-running mortgage industry survey conducted by Freddie Mac. Their survey (officially named the Primary Mortgage Market Survey, or PMMS) dates back to the 1970s and receives weekly updates. It is one of the most widely cited interest-rate trackers in the U.S.
I’ve tailored this chart to highlight two important trends:
Blue line = average rate for a 30-year fixed mortgage
Reddish line = average rate for a 5-year adjustable / ARM loan
As you can see, this chart shows mortgage rate trends over the past five years or so. You can also see the steep and prolonged downward trend that has occurred over the past couple of years (right side of chart).
In short, mortgage rates in the U.S. are a heck of a lot lower today than they were back in 2018. They actually set an all-time record low recently, when the average rate for a 30-year fixed home loan dropped to an incredibly low 2.87%. That was the first time in 50 years that had happened, to date.
To put that 2.87% figure into perspective: A few months ago, people in the mortgage industry were marveling that average rates were dropping toward 3% for a 30-year fixed home loan. Now they’re even lower, bouncing around within the upper-2% range. So yes, it’s a big deal.
Getting back to the point of this article. This chart also illustrates the mortgage rate trend “shakeup” that happened during 2020.
Take a look at where the blue line dips down to meet the red line. That event happened back in April of 2020, when the average rate for a 30-year fixed mortgage dropped so far that it began to compete with the 5-year ARM.
There were even a couple of weeks there when the 5-year ARM average rate rose above the 30-year fixed. You can see that over on the right side of the trends chart, where the red line rises above the blue one. A rare occurrence, indeed.
Zooming Out: The Past 10 Years at a Glance
The chart below shows the same mortgage rate trends as the one above. Only here, I’ve “zoomed out” to include the past ten years instead of just five.
Again, you can see how the traditional relationship between the 30-year fixed-rate mortgage and the 5-year ARM (with ARMs being cheaper) started to change in 2020. We’ve entered uncharted territory, in that regard.
Here’s what home buyers and homeowners should now about all of these mortgage rate trends, as we approach the last two months of 2020. Now is a great time to use a 30-year fixed home loan to buy or refinance a home in the U.S. You could land a very low rate, while also enjoying the long-term stability offered by a 30-year mortgage product.
ARM vs. Fixed: It’s an Easy Call These Days
In light of recent mortgage rate trends (which could persist into 2021), it has become harder and harder to make a case for the ARM loan.
Adjustable-rate mortgages like the 5/1 ARM used to offer borrowers a short-term reward, in the form of a lower interest rate. The idea was that you could use the ARM to secure a comparatively lower rate, and then refinance down the road before the adjustments kicked in.
But now, with the mortgage rate trends we’ve seen over the past few months, there just isn’t much reason to go with the riskier ARM option.
Darrin English, a senior loan officer for Quontic Bank, recently told Business Insider:
“I can’t see one good reason why someone would choose to go with an ARM versus a 30-year fixed rate in today’s market. Why take the risk when you can get a better rate in a 30-year loan?”
That’s a hard point to argue. There are few, if any, good reasons to use an adjustable and unpredictable home loan in light of current mortgage rate trends in the U.S. The one and only advantage they used to offer (a lower rate) largely evaporated during the spring and summer of 2020.