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In this post, we take a look at the different characteristics 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 actually chosen to use the 2019 SCF since it does not consist of any of the changes and characteristics connected with the COVID-19 pandemic, which are beyond the scope of this post. Motivated by the current high mortgage rates, which can make outstanding ARMs more expensive when their rates reset, we have an interest in finding out which borrowers are exposed to these higher rates. We found that families holding ARMs were younger and earned greater incomes which their preliminary mortgage sizes were larger and had larger outstanding 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 remaining 8% have adjustable rates. Fixed-rate mortgages have a set interest rate for the life of the loan, which must be paid on top of the principal loan quantity. Adjustable-rate mortgages have rates that generally track a benchmark rate that reflects existing economic conditions and is more carefully 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 fixed for an initial period, usually 5 or 7 years, after which the rate is usually reset yearly 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, during the Fed's existing tightening period, 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 indicates the rate is totally free to change every year after being repaired for the very first 5 years. rose from 4.1% to 7.6% during the same period. To put this in point of view, consider a family that obtained $200,000 using a 5/1 ARM in October 2018. This family made month-to-month payments of $964 throughout the first five years of the mortgage. The month-to-month 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 locked in the lower rate for the life of the loan. Given this danger, fixed-rate mortgages generally have greater introductory rates. Had the household secured 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 constant in 2023.

Mortgage payments represent about 30% of home income, 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 considerable additional concern on families.

Identifying Households with ARMs

To comprehend which homes are most affected by modifications in rates of interest through ARMs, we computed the share of households with mortgages that hold either ARMs or fixed-rate mortgages throughout the income circulation and compared some general characteristics of these households and their mortgages, consisting of the rates, the initial size of the mortgages, and the staying balance.

The figure below programs the share of mortgages by earnings 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 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 greater among families in the higher-income deciles: 18.8% in the top 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 explanation for why holding ARMs is more concentrated in higher-income deciles is that homes with greater income are more able to absorb the danger of higher payments when rates of interest increase. In exchange, these families can benefit immediately from the lower introductory rates that ARMs tend to have. On the other hand, families with lower income may not have the ability to afford their mortgage if rates adapt to a considerably greater level and hence choose the predictability of fixed-rate mortgages, especially since they have the alternative to refinance at a lower rate if rates drop.

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

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

ARMs Appear to Skew toward Younger, Higher-Income Households

In sum, ARMs seem to be more popular with younger, greater income families with larger mortgages, and ARM ownership relative to fixed-rate ownership nearly tripled from the bottom to leading earnings decile. Given their age and income, these types of homes might be better equipped to weather the threat of changing rates while their proportionally bigger mortgages take advantage of the lower initial rates.

Notes

1. Despite the recent release of the 2022 SCF, we have actually chosen to use the 2019 SCF because it does not include any of the changes and dynamics connected with the COVID-19 pandemic, which are beyond the scope of this article. 2. Although rates for ARMs are designed to be adjustable, rates on ARMs are frequently fixed for an introductory period, normally 5 or 7 years, after which the rate is generally reset every year or two times a year. Additionally, ARMs may have restrictions on just how much the rates can change and a total cap on the rate.