In this post, we look at the various characteristics of households holding adjustable-rate mortgages (ARMs) and fixed-rate mortgages in the 2019 Survey of Consumer Finances (SCF). Despite the current release of the 2022 SCF, we have actually selected to utilize the 2019 SCF due to the fact that it does not consist of any of the changes and characteristics related to 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 are interested in discovering which customers are exposed to these greater rates. We found that homes holding ARMs were more youthful and made greater incomes and that their initial mortgage sizes were bigger and had bigger exceptional balances compared with those holding fixed-rate mortgages.
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Characteristics of ARMs

About 40% of U.S. homes have mortgages, of which 92% have fixed rates and the staying 8% have adjustable rates. Fixed-rate mortgages have a set rates of interest for the life of the loan, which should be paid on top of the principal loan amount. Adjustable-rate mortgages have rates that generally track a benchmark rate that reflects existing financial conditions and is more closely affected by the interest rate set by the Federal Reserve.Although rates for ARMs are developed to be adjustable, rates on ARMs are frequently fixed for an initial period, normally five or 7 years, after which the rate is generally reset each year or twice a year. Additionally, ARMs may have restrictions on how much the rates can change and a general cap on the rate.

For instance, during the Fed's current tightening duration, 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 each year after being fixed for the first five years. rose from 4.1% to 7.6% throughout the very same period. To put this in perspective, think about a household that obtained $200,000 utilizing a 5/1 ARM in October 2018. This family made monthly payments of $964 throughout the very first 5 years of the mortgage. The monthly 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 secured the for the life of the loan. Given this risk, fixed-rate mortgages generally have higher initial rates. Had the home gotten 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 consistent in 2023.

Mortgage payments represent about 30% of home income, and as we revealed in an earlier Economic Synopses essay, impressive mortgages represent about 70% of home liabilities, so this boost in regular monthly payments represents a substantial additional burden on households.

Identifying Households with ARMs

To comprehend which families are most affected by changes in interest rates through ARMs, we calculated the share of homes with mortgages that hold either ARMs or fixed-rate mortgages throughout the earnings distribution and compared some general attributes of these households and their mortgages, consisting of the rates, the preliminary 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 total mortgages.

Distribution of Kinds Of Mortgages by Income Decile

SOURCES: 2019 Survey of Consumer Finance and authors' calculations.

NOTE: Households are divided into income deciles, in which the first decile represents those with the most affordable earnings and the 10th represents those with the highest income.

As displayed in the figure, the share of mortgages that have adjustable rates is usually higher among households in the higher-income deciles: 18.8% in the top decile (the 10th) compared with 6.5% in the bottom decile (the very 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 focused in higher-income deciles is that families with higher income are more able to take in the threat of higher payments when interest rates increase. In exchange, these families can benefit right away from the lower introductory rates that ARMs tend to have. On the other hand, homes with lower earnings may not be able to afford their mortgage if rates get used to a considerably higher level and thus choose the predictability of fixed-rate mortgages, particularly because they have the option to re-finance at a lower rate if rates drop.

The table below reveals some other general attributes of ARMs and their borrowers versus those of fixed-rate mortgages and their customers.

ARMs tend to have lower interest rates. However, the average initial borrowing quantity is over $40,000 larger for ARMs, and the typical remaining balance that families still require to pay is also bigger. The average family income among ARM holders is likewise 50% more than the median income of those holding fixed-rate mortgages. This is constant with the figure above, in which the share of ARMs increases amongst higher-income families. The mean age of ARM holders is also 18 years lower.

ARMs Appear to Skew toward Younger, Higher-Income Households

In sum, ARMs appear to be more popular with younger, greater earnings households with larger mortgages, and ARM ownership relative to fixed-rate ownership nearly tripled from the bottom to leading income decile. Given their age and income, these types of households may be much better geared up to weather the threat of varying rates while their proportionally larger mortgages take advantage of the lower introductory rates.
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Notes

1. Despite the recent release of the 2022 SCF, we have actually picked to utilize the 2019 SCF because it does not include any of the changes and characteristics connected with the COVID-19 pandemic, which are beyond the scope of this blog site post.

1. Although rates for ARMs are developed to be adjustable, rates on ARMs are typically fixed for an initial period, typically five or seven years, after which the rate is generally reset yearly or two times a year. Additionally, ARMs might have limitations on just how much the rates can change and an overall cap on the rate.