Falling mortgage rates don't stop borrowers from choosing ARMs

Key takeaways

• Overall mortgage applications were up 0.4% week over week as of Friday, driven by a 4% increase in refinances, according to the Mortgage Bankers Association.
• Despite lower borrowing costs, purchase applications dropped 5% week over week.
• Adjustable-rate mortgages gained traction as buyers look for more affordable options.

Borrowers are taking advantage of the lowest mortgage rates in years — and more are opting for adjustable-rate mortgages as an even more affordable path to homeownership.

In the week ended Feb. 20, mortgage applications increased 0.4% from the previous week, according to the Mortgage Bankers Association's market index. It's the second consecutive week of demand growth.

The increase was mostly driven by a 4% week-over-week increase in refinancing. Applications for home purchases decreased 5% during the same time.

This week's data speaks to the mixed picture that is the current housing market: Mortgage applications increased only modestly, even as borrowing costs fell to three-and-a-half-year lows — and stayed there. In fact, Tuesday was the second day in a row that the 30-year, fixed-rate mortgage was below 6%, according to Mortgage News Daily.

Economists have suggested a few reasons for that mismatch. For one, it usually takes buyers time before they decide to actually enter the housing market.

Lawrence Yun, chief economist at the National Association of Realtors, noted last week that lower mortgage rates could make ownership affordable to an additional 5.5 million households — but it would take time for that to manifest into actual transactions.

"Most newly qualifying households do not act immediately, but based on experience, about 10% could enter the market — potentially adding roughly 550,000 new homebuyers this year compared with last year," he said in a statement Thursday.

The other possible explanation: the data is playing catch-up. The MBA's index doesn't account for this week's sub-6% mortgage rates. It also shows a more positive trend on a yearly basis. Refinance applications were 150% higher than the same time last year, and purchase applications were 12% higher than the same time a year earlier.

"There's too much noise in the week-to-week changes to draw any useful conclusions," Brad Case, chief residential economist for Homes.com, said in an earlier interview.

For those buyers who do want to get into the housing market now, adjustable-rate mortgages are gaining popularity, according to the MBA's data.

In the week ended Friday, 8.2% of all mortgage applications were for ARMs. Unlike fixed-rate mortgages that come with a set interest rate, ARMs are characterized by variable interest rates. An ARM allows a borrower to lock in one rate for a set period — five or seven years, for example — and that rate is usually lower than you would get with a conventional, fixed-rate loan.

For example, as of Tuesday afternoon, the ARM tracked by Mortgage News Daily was at 5.29% — 70 basis points below the 30-year, fixed-rate mortgage. That's incentivizing "payment-sensitive borrowers or those seeking larger loans," according to Joel Kan, MBA's vice president and deputy chief economist.

It's a continuation of a trend that's started showing up in the week-over-week data this year as buyers look for more affordable ways to enter the housing market.