Adjustable-Rate Mortgages Caused Trouble in 2008. They’re Worrying Experts Again

As the country reemerged from the coronavirus pandemic lockdown in 2021, when the COVID-19 vaccine finally arrived, TikTok reached 1 billion downloads and Adele finally released new music — the housing market also saw its own interesting development. That year, banks offered some of the lowest interest rates seen in over a decade for a type of housing loan known as an adjustable-rate mortgage.

If that term sounds familiar but you can’t place exactly where it’s from, think way before COVID-19 and TikTok. Think 2008 — interestingly enough, when Adele released her first album. Adjustable-rate mortgages (or “ARMs” for short) made headlines back then for comprising a big chunk of the foreclosures that brought down the housing market.

An ARM, to be more precise, is a loan with a monthly interest rate that stays fixed for an initial amount of time — there are options for five, seven and even 10 years. But unlike the more conventional 15- or 30-year fixed mortgage, an ARM’s rate will change after that first period — up or down, depending on where the housing market is then — and keep changing periodically until the borrower pays off the loan.

ARM rates have gone up significantly since the pandemic — for example, the average rate for a 5/1 ARM (which promises a fixed interest for the first five years, then changes annually) stayed below 3% for almost all of 2021. Rates for that same kind of mortgage, as of this story’s publishing time, have nearly doubled since then, with many lenders currently offering rates above 6%.

• Jump to: What experts recommend if you’re expecting an increase in your ARM rate this year

Many families with a 5/1 ARM could see significantly higher payments when their new rate kicks in this year, said Julian Vogel, assistant professor of finance at San José State University and chartered financial analyst.

“Combined with the difficult job market situation, where fewer people can find adequate employment, higher payments will put a significant strain on a lot of households,” he said, before adding that both the housing market and the laws that regulate it have changed significantly since the last housing crash.

While he doesn’t think “it will be as big of a deal as in 2008” for the market as a whole, individual households could face some serious financial challenges.

Keep reading to hear what insight financial experts shared with KQED on how borrowers can prepare for potentially higher monthly payments and what everyone else needs to know about how this change in the housing market could impact the overall economy.

How do ARMs work?

ARMs tend to have lower starting rates than the typical 30-year fixed mortgage many are familiar with, but they also come with a certain level of uncertainty. “Clients that really expect their income to grow over those periods are willing to make that risk trade-off, knowing that in the future, that rate could adjust either up or down,” said Matt Vernon, head of consumer lending at Bank of America.

Who — or what — decides interest rates? If you’re thinking it’s the Federal Reserve, that’s partially right, but not the whole answer.

As the nation’s central bank, the Federal Reserve can change the benchmark interest rate, which is how much banks can charge when borrowing from each other. That number then acts like a baseline for the interest rate banks offer their customers (including on car loans and credit card debt). When rates are low, more people borrow and spend, injecting more money into the economy (This is why President Donald Trump has pressured the Federal Reserve for months to slash interest rates despite concerns about the possibility of higher inflation.).

For a mortgage, other factors also influence interest rates, including the borrower’s credit score, job and location of the property, along with how many other people are interested in a similar loan. A mortgage, after all, is like any other good in the economy, where price — the rate — is determined by supply and demand. The more people want mortgages, the higher the rate.

What’s the risk for the economy?

The economic slowdown of 2020 led to the super-low rates of 2021, a year that saw 15 million mortgages nationwide, including both ARMs and fixed loans. “We saw a lot of people take out mortgages then because they were unhappy with their living situation, which was at the forefront of their minds during the pandemic and lockdown,” Vogel said.

ARMs, however, ended up being only a tiny piece of the post-pandemic mortgage rush.

According to data from the Mortgage Bankers Association, ARMs made up less than 5% of all home loan applications in 2021. That’s a different picture from where the country was leading up to the 2008 financial crisis. Soon after the housing market collapsed, the Federal Reserve found that more than 75% of mortgages offered to borrowers with bad credit (the infamous “subprime mortgages”) had been some type of ARM. Many borrowers who had received an ARM were financially unprepared when their rates went up and ended up having their homes foreclosed.

Having fewer ARMs this time around is a relief for some experts like Vogel, who points out that even if many folks with ARMs fail to make their payments, the number of potential foreclosures will most likely not reach 2008 levels.

“We’re not going to see a financial crisis of that measure originate from ARMs,” he said, “but that is mostly because I could see a different, much stronger financial crisis arising from the overall increase in the cost of living and unemployment rate.”

I have an ARM and expect my rate to change this year. What should I know?

If you secured a 5/1 ARM in 2021, you should receive a notice from your lender this year before your rate actually changes. If you are worried about your ability to pay your new rate, talk with your lender as soon as you can, said Nikki Beasley, executive director of Richmond Neighborhood Housing Services, which helps prepare families in Alameda and Contra Costa counties for homeownership.

You should confirm with your banker or mortgage company the loan’s reset date — when your mortgage will switch from the initial fixed-rate to adjustable rates — along with the rate cap and floor, which limit how much your payments can actually change in one year. If your reset date doesn’t kick in until, say, November, where rates are then will be much more relevant than where they are currently in January.

“This is not the time to shut down, to have shame, be embarrassed or have fear,” Beasley said. “Be as transparent as you can be with your lender to say what you can do or what you can’t do.”

It’s helpful to share with your lender any changes to your job, income or personal spending habits that have come up since you first signed the mortgage, Beasley added. A housing counseling agency approved by the Department of Housing and Urban Development — like Beasley’s Richmond Neighborhood Housing Services — can also help you organize your budget and make a plan to avoid foreclosure. Find your nearest HUD-approved housing counseling agency.

One option you can also consider is refinancing — replacing your current loan with a new one, giving you the opportunity to secure a different rate or payment plan. In some cases, a borrower can even switch from an ARM to a fixed-rate mortgage, allowing for more stability in monthly payments.

“It’s important for the consumer to be really transparent with their lending specialist on what are the goals that they’re trying to achieve [with refinancing],” Vernon said. “Do they want lower payments? Do they have the need to access equity or cash? Do they want to shorten the term of their loan?”

Keep in mind that refinancing usually comes with closing costs — additional fees that you’re charged for switching over to a new loan. And just because you want a refinance doesn’t necessarily mean the bank will give you one.

“They may not qualify if their credit score is too low, they’re unable to verify income or their income has changed from what they had when they initially qualified for the loan that they have today,” Vernon said, adding that your financial objectives should also align with the new loan you’re seeking.

And if you’re in the difficult position of no longer being able to afford the home at all, also communicate that with your lender, recommended Beasley. “The sooner that you figure that out, you can then have a more graceful transition plan,” she said. “Maybe you are looking to sell, maximize the equity or get something smaller.”

“Be more proactive, so you are making this transition with grace, versus it being a very traumatic situation because you didn’t deal with the problem soon enough,” she added.