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The Rising Popularity of Adjustable-Rate Mortgages (ARMs) and 2/1 Buy-Downs: A Risky Trend in the Housing Market

Continue our discussion on real estate investing where we de-bunked some of the myths that are just too good to true, today we will talk about the gaining popularity of Adjustable-Rate Mortgages. The housing market has been a topic of conversation and concern for many in recent times. Spiraling home prices and soaring mortgage rates have made it increasingly challenging for people to enter the market. In this post, we will delve into a recent trend that is raising eyebrows in the housing industry: the growing popularity of adjustable-rate mortgages (ARMs) and 2/1 buy-downs.

Understanding the Shift

Understanding the Shift

The Mortgage Bankers Association (MBA) recently released a report that sheds light on an alarming trend in the housing market. Homebuyers are becoming more creative in their financing options, primarily to make housing more affordable. One of the most significant indicators of this trend is the increasing preference for ARMs, particularly the 5/1 ARM.

The 5/1 ARM is a loan product that starts with a fixed interest rate for the first five years and then shifts to a variable rate thereafter. This shift towards ARMs raises questions about the financial risks associated with such a choice. Let’s take a closer look at this trend, its implications, and the reasons behind it.

The MBA Report

According to the MBA report, applications for ARMs have surged by a staggering 15% in just one week. Even more concerning is that ARMs now constitute 99.2% of all loan applications, marking the highest levels seen since November of 2022. This is a stark contrast to the figures from a year ago when ARMs made up only a fraction of the market.

One of the primary drivers of this trend is the skyrocketing 30-year fixed mortgage rates, which have reached 7.67%. This is the highest level we’ve seen since the year 2000, and it represents a significant increase of approximately 40 basis points in just one month. With rates inching closer to 8%, many potential buyers are looking for alternative ways to make homeownership more affordable.

The Impact on Purchase Applications

The MBA report also highlights the impact of this trend on purchase applications. While the seasonally adjusted purchase index showed a 1% increase from one week ago, it is down by a staggering 19% from one year ago. This downturn in purchase applications underscores the challenges faced by homebuyers in the current market.

Joel Khan, the MBA’s Vice President and Deputy Chief Economist, noted that while most mortgage rates increased last week, rates on ARMs decreased. This led to an overall increase in ARM applications and an uptick in overall application activity.

The Risks of ARMs

The Risks of ARMs

So, why are so many homebuyers turning to ARMs despite the risks involved? The appeal of ARMs lies in their initial lower interest rates compared to fixed-rate mortgages. For instance, a 5/1 ARM might offer a rate of 6.33%, which is significantly lower than the prevailing rate for a 30-year fixed mortgage.

However, the key concern with ARMs is their variable nature. After the initial fixed period of five years, the interest rate becomes variable and adjusts annually. This means that homeowners are at the mercy of market conditions and potential rate hikes. The question arises: will buyers be able to handle the increased payments when their rates start to adjust?

Consider this scenario: A homebuyer purchases a $500,000 home with a 20% down payment, resulting in a loan balance of $400,000. With a 30-year fixed rate at 7.67%, their monthly principal and interest payment would be approximately $2,843.

Now, let’s compare this to a 5/1 ARM with an initial rate of 6.33%. With the ARM, their monthly payment would be around $2,483. This might seem like a significant savings of $360 per month. However, it’s important to remember that this rate is only fixed for the first five years. After that, it becomes variable, subject to market fluctuations.

The question then becomes whether the homeowner will be financially prepared for potential rate hikes and increased monthly payments after the initial five-year period. This uncertainty and risk are what make ARMs a potentially precarious choice for many homebuyers.

The Appeal of 2/1 Buy-Downs

In addition to ARMs, some homebuyers are exploring another option known as the 2/1 buy-down. This financing strategy allows buyers to lower their initial interest rates for the first two years. During the first year, the interest rate decreases by 2 percentage points from the prevailing rate at the time of purchase. In the second year, it decreases by 1 percentage point. Afterward, the rate adjusts to the prevailing market rate.

While 2/1 buy-downs can offer lower initial monthly payments, they also carry significant risks. The decreased rates are temporary, and buyers must be prepared for the eventual rate adjustments. The key question here is whether buyers will be financially stable when the rates start to increase after the initial two-year period.

Consider a scenario where a homebuyer opts for a 2/1 buy-down on their $500,000 home with a 20% down payment. With the prevailing rate at 7.67%, their initial monthly payment would be around $2,314 during the first year. This may seem like a substantial reduction compared to a 30-year fixed-rate mortgage, but it’s essential to remember that this is a short-term benefit.

In the second year, the rate increases slightly to 6.67%, resulting in a monthly payment of $2,573. After the initial two-year period, the rate adjusts to the prevailing market rate of 7.67%, bringing the monthly payment back up to $2,843.

The crucial consideration here is whether the homebuyer’s financial situation will allow them to absorb the increased payments in the second and subsequent years. This uncertainty is what makes 2/1 buy-downs a potentially risky choice.

The Dangers of Risky Loan Products

The increasing popularity of ARMs and 2/1 buy-downs in the housing market raises significant concerns. While these options can offer short-term savings, they also come with substantial risks. Homebuyers who opt for these products may find themselves in precarious financial positions when rates start to adjust.

There are several critical factors to consider:

  • Income Stability: Will your income remain stable and sufficient to cover increased payments when rates adjust? Job security and future earning potential are essential considerations.
  • Refinancing Options: Do you have a clear plan for refinancing into a more stable mortgage when rates become variable? Refinancing can be challenging if market conditions or personal financial situations change.
  • Market Uncertainty: Predicting future interest rates is challenging. You may face rate increases that significantly impact your monthly payments.
  • Long-Term Planning: Homeownership is a long-term commitment. Consider whether the initial savings are worth the potential financial stress down the road.


The current trend of increasing ARMs and 2/1 buy-downs in the housing market reflects the challenges that homebuyers face in a competitive and expensive environment. While these financing options can provide short-term relief, they also come with significant financial risks.

Before choosing an ARM or a 2/1 buy-down, it’s crucial to assess your financial stability, long-term goals, and risk tolerance. Homeownership is a significant investment, and the decision should be made carefully, with a clear understanding of the potential consequences.

As we navigate the ever-evolving landscape of the housing market, it’s essential to stay informed, seek expert advice, and make well-informed decisions that align with your financial future. Remember that while affordability is crucial, financial stability and peace of mind are equally valuable.

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