As Mortgage Rates and Home Prices Climb, Buyers Turn to Riskier Loans

April 30, 2024

Mortgage rates continued to climb this week, reaching the highest levels since last November. At the same time, home prices continue to climb amid historically low inventory. The combination of higher prices and higher borrowing has left many buyers considering risker mortgage options.

The average rate on a standard 30-year fixed mortgage with conforming loan balances ($766,550 or less) increased to 7.29% last week, up from 7.24% the week prior. That is the highest rate since last November, when mortgage rates reached the highest level in decades. 

Mortgage rates retreated somewhat at the start of the year, hovering in the 6% range through mid-February, but concerns that the Federal Reserve will keep interest rates elevated in the face of persistent inflation have caused them to begin climbing again.

This has resulted in fewer potential sellers putting their homes on the market, as they are locked in to substantially lower rates. The lack of available homes on the market has meant that prices for the limited inventory has sent prices steadily higher. Home prices in March jumped 6.4% year-over-year in March, according to the S&P CoreLogic Case-Shiller national home price index. That is the fastest annual pace of price growth since November 2022.

The one-two punch of higher prices and more expensive borrowing has sent many buyers looking for other options. Demand for adjustable-rate mortgages (ARM) has grown significantly in recent months.

ARM loans are attractive to many buyers because they typically offer a lower initial rate for a fixed period, typically 5 or 10 years. The average contract rate for an ARM with a 5-year fixed rate was 6.60% last week. Because that is significantly lower than the 30-year fixed rate, This means that buyers will have a lower monthly payment with an ARM than with a traditional mortgage, at least initially. Once the “fixed” period of an ARM ends, the loans adjust to an unknown future market rate, which can be much higher. ARMs contributed to the 2007 housing crisis, as a wave of foreclosures hit borrowers unable to keep up with the ballooning payments.

The share of ARM applications rose to 7.8% of all mortgage demand last week, according to the Mortgage Banker’s Association. That is the highest level of the year and well above historical norms. In 2021, when mortgage rates were at record lows, the ARM share of mortgage demand was less than 3%.

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