Since 2009, I’ve been advising readers of Financial Samurai to choose adjustable-rate mortgages (ARMs) over 30-year fixed-rate mortgages, given the declining interest rate environment. Why pay more when you don’t have to? Back then, the average duration of homeownership was only about 5-7 years, making a long-term fixed-rate mortgage an unnecessary expense. Nowadays, the duration has increased to over 10 years due to heightened interest in real estate.
Personally, I’ve consistently opted for ARMs and saved over $500,000 in mortgage interest over the years. My current primary residence, for instance, is financed through a 7/1 ARM at 2.125%, which I secured in 2020.
Despite my efforts to share these insights, it seems many have not followed this advice. A chart by Rick Palacios of JBREC shows that ARMs only make up 4.7% of total loans, which is far lower than my expected 25%. However, with rising mortgage rates in 2022 and 2023, the proportion of ARMs has increased to about 10%.
The decline in ARMs since their peak in 2005 can be attributed to several factors, including decreased housing demand, falling interest rates leading to more attractive fixed-rate mortgages, and a shift in lender and consumer preferences towards predictability after the real estate crash.
My recommendation for ARMs wasn’t to be contrarian but to genuinely help people save money. Since 2009, those who chose ARMs have benefitted from lower rates compared to 30-year fixed mortgages. Additionally, many could refinance to another ARM or let their rate adjust, often resulting in the same or lower rates.
I invested the savings from my mortgage in stocks and real estate, which significantly boosted my passive income. The 40-year downward trend in the 10-year U.S. Treasury bond yield supports this strategy.
In the current environment of rising rates, it’s wise to match the fixed duration of your mortgage with how long you plan to own your home or have the mortgage. Despite rising rates, I still advocate for ARMs, given the likelihood of rates reverting to their downward trend before the ARM adjusts.
If you find yourself in a situation where your ARM’s rate is set to increase significantly, you can prepare by setting aside reserves to pay down some or all of the principal balance. This proactive approach can help mitigate the impact of higher rates.
As more people seek to save money in the face of higher home prices and mortgage rates, I expect the proportion of ARMs to increase significantly, potentially surpassing 20% in the next few years.
For those investing in real estate, now is an opportune time to look for deals and consider platforms like Fundrise for diversified real estate investments, especially in lower-cost areas with strong demographic trends. My own investment of $810,000 in private real estate funds focused on the heartland of America has been a rewarding way to diversify my portfolio and generate additional passive income.
