LOS ANGELES – More than 12% of borrowers applied for adjustable-rate-mortgages (ARMs) in June and July, the highest percentages since August 2007, according to a new Zillow analysis.

And borrowers using ARMs are likely to be affluent households with larger down payments.

Data from last year shows the median income of a borrower receiving an ARM was $165,000 compared with $91,000 for all borrowers, Zillow figures show. And the typical ARM borrower put down 23.6%, while the typical overall borrower put 10% down.

Given this, it’s likely today’s typical ARM borrower would be able to withstand increased monthly mortgage payments if rates rise, the analysis concluded.

It’s all about closing that gap of higher home prices, soaring fixed rates (this week, Freddie Mac noted the average 30-year fixed-rate mortgage jumped to 5.66%, almost double one year ago) and trying to find a house payment you won’t choke on. I tend to see big mortgage rate spreads between ARMs and fixed rates, making ARMs worth considering when the loan balance is above $647,200. These better rates tend to come from bank depository funds and credit union depository funds, also known as portfolio ARMs.

Take for example a borrower with good credit buying a $1 million home with 20% down. Fannie Mae’s fixed-rate for a 30-year loan of $800,000 is 5.875% with roughly a one-point cost. The principal and interest payment would be $4,732 per month.

The rate for a 10-year portfolio ARM is 4.615% with a one-point cost. That payment would be $4,108, saving a whopping $624 per month and $74,880 over 10 years.

Rates are locked during the introductory period, which can be for three, five, seven or 10 years. So, the tradeoff for a significantly lower house payment is the risk of rates adjusting upward after the introductory period ends. Rates can go up, go down or stay the same, based on an index (typically the secured overnight financing rate, or SOFR) plus a profit margin.

ARMs also have a “life cap,” or a maximum rate hike over the life of the loan.

Mortgage servicers using the SOFR index calculate a new interest rate every six months, amortizing the remaining balance over the remaining number of months left on the loan. (The previous vintage of COFI ARMs tended to have annual adjustments.)

Say you took out a 30-year, $600,000 ARM five years ago with a five-year introductory rate. Your initial rate was 4% and your principal and interest payments were $2,864 a month. Your remaining balance is $543,747.

Today’s 30-day SOFR index is 2.284%. Adding in an assumed profit margin of 2.75% brings your new rate to 5.034%. Your new payment jumps by $325 to $3,189 a month because the new rate jumped by more than 1%.

Most adjustable-rate mortgages require the initial principal and interest payment to be based on a 30-year term. There also are 40-year adjustable-rate mortgages, which come with interest-only payments for the first 10 years.

Interest-only rates also are available for three, five, seven and 10-year terms. This means you’d be required to pay just the interest for the introductory period, and your loan balance remains unchanged.

For a 10-year, $800,000 ARM, the rate would be 5.5% and the interest-only payment would be $3,667 a month. That’s $441 less than the $4,108 payment on a 10-year amortizing ARM, which covers both interest and a small portion of the loan balance.

Qualification requirements are much tougher for interest-only loans.

The key factors to look at when considering an ARM are the points and costs, the initial rate, the introductory period, the index used, the profit margin and the life cap.

© Copyright © 2022 Pasadena Star-News. Jeff Lazerson is a mortgage broker.