Is an ARM Loan a Good Idea in 2023, for California Home Buyers?

Mortgage rates have risen substantially over the past couple of years. As a result, more and more California home buyers are turning to the adjustable-rate mortgage (ARM) loan to secure a lower interest rate.

But is an ARM loan a good idea in 2023, based on your home-buying goals? Here’s how to figure it out.

Mortgage Rates Rise in Fall 2023

Yesterday, the average rate for a 30-year fixed-rate mortgage loan hit its highest level since the year 2000. That’s based on the long-running weekly survey conducted by Freddie Mac, the government-sponsored mortgage buyer.

Thirty-year mortgage loans held an average rate of 7.31% this week. A year ago, that average was hovering around 6.7%, and a year before that it was around 3%. This means rates have more than doubled in two years’ time.

Historically speaking, we tend to see a rise in the use of adjustable-rate mortgage loans during times when mortgage rates rise significantly. That’s because ARMs usually start off with a lower interest rate, when compared to the 15- and 30-year fixed-rate mortgage options.

And that seems to be the case here as well, as of early fall 2023. Last week, the Mortgage Bankers Association’s (MBA) reported that “the adjustable-rate mortgage (ARM) share of activity increased to 7.5 percent of total applications.”

The 30-year fixed-rate home loan is still the most popular financing option among home buyers and homeowners in California. It accounts for the vast majority of mortgage lending activity. But the ARM loan has clearly gained popularity in recent weeks, partly due to the higher mortgage rates we are seeing these days.

And that leads us to a question on the minds of many borrowers:

Is an ARM loan a good idea in 2023, from a buyer’s perspective? And what about next year? Will it make sense to use an ARM loan in 2024, when buying a house in California?

There are some scenarios where it makes sense to use an adjustable-rate mortgage loan. It can be a money-saving tool under the right circumstances.

We will get to those circumstances in just a moment. But first, let’s explore the common features and “inner workings” of a typical ARM loan in California.

What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage (ARM) loan is a type of mortgage loan where the interest rate can change periodically over the life of the loan. This is in contrast to a fixed-rate mortgage, where the interest rate remains the same for the entire life of the loan.

ARMs are typically structured as follows:

• Initial fixed-rate period: The loan begins with a fixed interest rate for a set period of time, typically 3, 5, 7, or 10 years.
• Adjustment period: After the initial fixed-rate period, the interest rate adjusts periodically, usually once a year, based on a benchmark index, such as the one-year Treasury bill rate.
• Margin: The margin is a spread that the lender adds to the benchmark index to arrive at the new interest rate, after the initial fixed phase has ended.

When an ARM Loan Might Be a Good Idea

So, is an ARM loan a good idea in 2023? Here are some scenarios when a California home buyer might want to consider using an adjustable-rate mortgage:

1. If you plan to sell the home in a few years.

ARMs typically have lower starting interest rates than fixed-rate mortgages, so you could save money on your monthly payments early on. And if you sell the home before the interest rate adjusts, you won’t have to worry about your payments increasing.

2. If you have a strong and consistently reliable cash flow.

ARMs can be a good option for borrowers who can afford to make higher monthly payments if interest rates rise. If you have a stable income and expect it to continue to grow, you may be able to handle the risk of an adjustable-rate mortgage.

3. If you plan to refinance your mortgage in a few years.

If you’re planning to refinance your mortgage after a few years, an ARM could be a good way to save money on your monthly payments in the meantime. However, it’s important to note that interest rates could rise by then, making it more expensive to refinance.

4. If you’re buying a starter home.

ARMs can be a good option for first-time home buyers in California who are looking for a lower monthly payment. Just be sure to have a plan in place for what you’ll do if interest rates rise and your monthly payments increase.

What are your financial goals for the future? If you’re planning to stay in your home for a long time, a fixed-rate mortgage may be a better option. However, if you plan to sell the home in a few years or refinance your mortgage, an ARM could be a good way to save money on your monthly payments in the meantime.

The Importance of Exploring Your Options

As you can see, mortgage lending is not a one-size-fits-all type of situation. You have your own unique financial situation and long-term housing goals. So you want to choose a type of mortgage loan that helps you achieve those goals. You want the best “fit.”

You also have additional choices that go beyond the whole fixed-versus-adjustable decision. For instance, you can choose whether or not you want to pay discount points at closing, in exchange for a lower interest rate.

All of this underscores the importance of working with a knowledgeable mortgage professional—someone who will take the time to help you understand your options.

As a mortgage broker, we have access to multiple lenders with many different home loan options. This allows us to match each individual client with the most suitable type of mortgage loan based on their unique situation.

Maybe an ARM loan is a good idea. Or maybe you would be better off using a long-term fixed-rate mortgage. There are pros and cons to all of these choices. We’ll help you understand them to make a more informed decision!