More Homebuyers Taking up ARMs

First American Financial Corporation, a provider of title, settlement and risk solutions for real estate transactions, has released the May 2022 First American Real House Price Index (RHPI). 

The RHPI measures the price changes of single-family properties throughout the U.S. adjusted for the impact of income and interest rate changes on consumer house-buying power over time at national, state and metropolitan area levels. Because the RHPI adjusts for house-buying power, it also serves as a measure of housing affordability. 

All in all, First American found that on a national level, house buying power decreased to $374,814 from $384,648 in April. Average household income increased by 4.6% to $71,340 from $71,190 while mortgage rates increased to 5.2% from 5% in April. 

Real house prices increased 3.8% from April 2022 and 50.8% from last year. 

The five states with the greatest year-over-year increase in the RHPI are: Florida (+72.1%); South Carolina (+63.3%); Arizona (+59.1%); Georgia (+57.8%); and North Carolina (+56.6%). There were no states with a year-over-year decrease in the RHPI. 

“In May 2022, the Real House Price Index (RHPI) jumped up by 50.8% year over year, which is the fastest growth in the more than 30-year history of the series. This rapid annual decline in affordability was driven by a 20.1% annual increase in nominal house prices and a 2.3 percentage point increase in the 30-year, fixed-mortgage rate compared with one year ago,” said Mark Fleming, Chief Economist at First American. “For home buyers, one way to mitigate the loss of affordability caused by a higher mortgage rate is with an equivalent, if not greater, increase in household income. Even though household income increased 4.6% since May 2021 and boosted consumer house-buying power, it was not enough to offset the affordability loss from higher mortgage rates and fast-rising nominal prices." 

“As affordability wanes, potential home buyers are looking to adjustable-rate mortgages (ARMs) for the lower rate benefit,” said Fleming. “Given the lower mortgage rate that is typically offered on an ARM today, compared with the 30-year, fixed-rate mortgage, ARMs offer prospective first-time home buyers an option to recapture some house-buying power in a rising rate environment.” 

“Since the beginning of 2022, the 30-year, fixed mortgage rate has increased 1.8 percentage points. While the rates on ARMs have increased too, ARMs have lower rates than 30-year, fixed-rate mortgages,” said Fleming. “According to the Mortgage Bankers Association’s weekly survey, the average rate on the 30-year, fixed-rate mortgage was 5.45% in May, while the average rate on a five-year ARM was 4.46%." 

“Consumer house-buying power, how much one can buy based on average household income and a given mortgage rate, increases when the mortgage rate drops,” said Fleming. “In fact, at those rates, an ARM increases consumer house-buying power by nearly $44,000 when compared with a traditional 30-year, fixed-rate mortgage. This could be a game-changer for many first-time home buyers." 

“Because ARMs offer a lower mortgage rate, there has been a steady increase in the share of ARM loans as mortgage rates have increased. For the month of May, the average share of ARM loans was up to 9.8%, compared with 3.9% one year ago,” said Fleming. “As all mortgage rates continue to increase, the share of ARM financing will likely increase.” 

So knowing all of this, are ARMs the answer? 

“While ARMs were a symbol of the housing market crash, today’s ARMs are very different. They offer reduced risk of significant payment shock when the fixed-rate period ends and rates become adjustable,” Fleming concluded. “As long as the ‘spread’ between ARMs and fixed-rate mortgages continues, more first-time home buyers may choose ARMs because the lower mortgage rate gives them a purchasing power ‘boost’ over the 30-year, fixed-mortgage rate.” 

Click here to view the report in its entirety.