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Will Rising Mortgage Rates Trigger an 'ARMs' Race for Home Buyers?

In May 2022, the Real House Price Index (RHPI) jumped up by 50.8 percent year over year, which is the fastest growth in the more than 30-year history of the series. This rapid annual decline in affordability was driven by a 20.1 percent annual increase in nominal house prices and a 2.3 percentage point increase in the 30-year, fixed-mortgage rate compared with one year ago. For home buyers, one way to mitigate the loss of affordability caused by a higher mortgage rate is with an equivalent, if not greater, increase in household income. Even though household income increased 4.6 percent since May 2021 and boosted consumer house-buying power, it was not enough to offset the affordability loss from higher mortgage rates and fast-rising nominal prices.


“As long as the ‘spread’ between ARMs and fixed-rate mortgages continues, more first-time home buyers may choose ARMs because the lower mortgage rate gives them a purchasing power ‘boost’ over the 30-year, fixed-mortgage rate.”


 

As affordability wanes, potential home buyers are looking to adjustable-rate mortgages (ARMs) for the lower rate benefit. Given the lower mortgage rate that is typically offered on an ARM today, compared with the 30-year, fixed-rate mortgage, ARMs offer prospective first-time home buyers an option to recapture some house-buying power in a rising rate environment. 

The Rise of ARMs -- It’s All About House-Buying Power 

Since the beginning of 2022, the 30-year, fixed mortgage rate has increased 1.8 percentage points. While the rates on ARMs have increased too, ARMs have lower rates than 30-year, fixed-rate mortgages. According to the Mortgage Bankers Association’s weekly survey, the average rate on the 30-year, fixed-rate mortgage was 5.45 percent in May, while the average rate on a five-year ARM was 4.46 percent. 

Consumer house-buying power, how much one can buy based on average household income and a given mortgage rate, increases when the mortgage rate drops. In fact, at those rates, an ARM increases consumer house-buying power by nearly $44,000 when compared with a traditional 30-year, fixed-rate mortgage. This could be a game-changer for many first-time home buyers. 

Because ARMs offer a lower mortgage rate, there has been a steady increase in the share of ARM loans as mortgages rates have increased. For the month of May, the average share of ARM loans was up to 9.8 percent, compared with 3.9 percent one year ago. As all mortgage rates continue to increase, the share of ARM financing will likely increase.

072222 RHPI

Are ARMs the Answer?

While ARMs were a symbol of the housing market crash, today’s ARMs are very different. They offer reduced risk of significant payment shock when the fixed-rate period ends and rates become adjustable. As long as the ‘spread’ between ARMs and fixed-rate mortgages continues, more first-time home buyers may choose ARMs because the lower mortgage rate gives them a purchasing power ‘boost’ over the 30-year, fixed-mortgage rate. 

For more analysis of affordability, please visit the Real House Price Index. The RHPI is updated monthly with new data. Look for the next edition of the RHPI the week of August 29, 2022. 

Sources:

May 2022 Real House Price Index Highlights

The First American Real House Price Index (RHPI) showed that in May 2022:

  • Real house prices increased 3.8 percent between April 2022 and May 2022.
  • Real house prices increased 50.8 percent between May 2021 and May 2022.
  • Consumer house-buying power, how much one can buy based on changes in income and interest rates, decreased 2.6 percent between April 2022 and May 2022, and decreased 20.4 percent year over year.
  • Median household income has increased 4.6 percent since May 2021 and 71.7 percent since January 2000.
  • Real house prices are 28.7 percent more expensive than in January 2000.
  • While unadjusted house prices are now 54.1 percent above the housing boom peak in 2006, real, house-buying power-adjusted house prices remain 9.3 percent below their 2006 housing boom peak.

 

May 2022 Real House Price State Highlights

  • The five states with the greatest year-over-year increase in the RHPI are: Florida (+72.1 percent), South Carolina (+63.3 percent), Arizona (+59.1 percent), Georgia (+57.8), and North Carolina (+56.6 percent).
  • There were no states with a year-over-year decrease in the RHPI.

 

May 2022 Real House Price Local Market Highlights

  • Among the Core Based Statistical Areas (CBSAs) tracked by First American, the five markets with the greatest year-over-year increase in the RHPI are: Tampa, Fla. (+66.7 percent), Raleigh, N.C. (+65.9 percent), Charlotte, N.C. (+65.7 percent), Miami (+63.1 percent) and Orlando (+62.9 percent).
  • Among the Core Based Statistical Areas (CBSAs) tracked by First American, there were no markets with a year-over-year decrease in the RHPI.

 

About the First American Real House Price Index

The traditional perspective on house prices is fixated on the actual prices and the changes in those prices, which overlooks what matters to potential buyers - their purchasing power, or how much they can afford to buy. First American’s proprietary Real House Price Index (RHPI) adjusts prices for purchasing power by considering how income levels and interest rates influence the amount one can borrow. 

The RHPI uses a weighted repeat-sales house price index that measures the price movements of single-family residential properties by time and across geographies, adjusted for the influence of income and interest rate changes on consumer house-buying power. The index is set to equal 100 in January 2000. Changing incomes and interest rates either increase or decrease consumer house-buying power. When incomes rise and mortgage rates fall, consumer house-buying power increases, acting as a deflator of increases in the house price level. For example, if the house price index increases by three percent, but the combination of rising incomes and falling mortgage rates increase consumer buying power over the same period by two percent, then the Real House Price index only increases by 1 percent. The Real House Price Index reflects changes in house prices, but also accounts for changes in consumer house-buying power. 

Disclaimer

Opinions, estimates, forecasts and other views contained in this page are those of First American’s Chief Economist, do not necessarily represent the views of First American or its management, should not be construed as indicating First American’s business prospects or expected results, and are subject to change without notice. Although the First American Economics team attempts to provide reliable, useful information, it does not guarantee that the information is accurate, current or suitable for any particular purpose. © 2022 by First American. Information from this page may be used with proper attribution.