The average monthly rate on 5/1 adjustable rate mortgages (ARMs) continues to climb in 2023, averaging 6.60% in the week ending March 10. Currently, the interest rate on the ARM rate is higher than the 15-year FRM rate and roughly level with the 30-year FRM rate. Thus, a riskier ARM is even less appealing to buyers seeking to increase their borrowing capacity beyond the amount allowed by an FRM.

ARM interest rates exceeded FRM rates in late 2022 as the Fed drove ARM rates up and the bond market allowed FRM rates to drift lower. This inversion in rates has completely eliminated the appeal of ARMs — and the price support ARMs provided before the inversion. 

Looking ahead, homebuyers who previously used ARMs to extend their purchasing power will be met with higher payments when the initial teaser rate period ends, destabilizing real estate markets when these ARMs reset five years forward.

This chart shows the average interest rate on a 5/1 ARM and a 30-year FRM since 2005.

This chart displays the average interest rates on a 5/1 adjustable rate mortgage (ARM) and a 30-year fixed rate mortgage (FRM). The gray bars represent periods of recession.

The Great Recession officially began in December 2007, ending an excruciating 18 months later in June 2009 when real estate prices finally bottomed.

During that time, the ARM-FRM crossover first took place mid-way through the recession, in December 2008 through the first half of 2009.

More recently, the average ARM rate (the blue line in the chart above) surpassed the 30-year FRM rate (the orange line) in August 2022. As of February 2023, the ARM has hovered near or above the FRM rate each month since August 2022.

Related charts:

Trending mortgage rates

Does this recent and consistent crossover movement indicate the U.S. is already in a recession?

It takes a while for economic recessions to be declared — always after the fact. So, it’s possible that the economic recession started sometime last year, especially following the two consecutive quarters of negative gross domestic product (GDP) that took place in 2022, the unofficial herald of a recession.

Yet, continued employment growth taints the economic picture, framed by the Fed’s fight to control runaway consumer inflation, forcing the economy to tread water in the first half of 2023. In the end, the recession’s dates will be up to the National Bureau of Economic Research (NBER) to declare.

But real estate professionals already know what is clear: the recession for housing arrived by mid-2022 and continues with vigor today.

Related article:

The votes are in: Still undeclared, the recession is already hitting California


Rising ARM use, cut short

Today’s ARM inversion was expected since these rates are tied directly to the Federal Reserve’s (the Fed’s) benchmark rate. Thus, when the Fed raises rates — as they did rapidly and significantly during 2022 — ARM rates rise an equal amount.

In contrast, FRM rates are heavily influenced by the bond market, which tends to accept lower long-term yields during times of economic uncertainty brought on by a severe shift in investment opportunities.

As the idea of the 2023 recession has solidified in the minds of investors, they have increasingly sought safe havens to park their funds. In turn, the bond market has softened to keep FRM rates from rising further while the Fed rate — which sets ARM rates — rose faster to fight inflation. Thus, an inversion in mortgage rates occurred, slashing homebuyer appeal of ARMs instantly. This ended the ARM’s price support influence. In time, the inflation fight will end, the Fed will drop its rates, and so too will go ARM rates.

But for those who turned to ARMs to extend their purchasing power in 2022, it’s too late.

Recent ARM homebuyers will be confronted with increased monthly payments when the initial teaser rate period ends. The payment increase is due to interest rate adjustments occurring in an environment of generally upward trending mortgage rates. Thus, any increase in ARM use adds a degree of instability to real estate markets when ARMs reset, five years forward from origination for home financing. To refinance with an FRM is out of the question until the Fed has conquered and reduced inflation.

Worse, as home prices continue to plunge from their May 2022 peak, homebuyers who purchased in 2020-2022 and put down less than 20% will quickly fall underwater in 2023-2024. Prices are expected to bottom here in California in early 2025 at near 50% of their peak May 2022 pandemic price distortion.

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Negative equity and foreclosure

Owing more on their mortgage than their home is worth, and faced with payment shock when their ARMs reset, these homeowners will disARM by turning to the put option present in every mortgage due to California’s anti-deficiency depression rules — default and force the mortgage servicer to foreclose and buy the property for the mortgage amount. Satisfaction guaranteed.

Real estate agents with an eye on mid-decade real estate services will prepare now for the rise in mortgage defaults and the resulting build up in lender inventory of real estate owned (REO) property. Sellers in the immediate future will have loss avoidance and a credit report ding on their mind, not profit taking. They are finding themselves standing in the queue that’s waiting to be called on by the next available buyer.

Agents can work with REOs by:

  • becoming REO specialists, advertising their expertise to buyers of REO property;
  • forming relationships with lenders to become their go-to listing agent for REOs;
  • forming real estate syndicates intent on investing in REOs; and
  • offering property management services for REOs.

In today’s shifting real estate market built on diminished buyer demand and falling prices, fee-based opportunities are springing up all around. But agents and their brokers need to get out of their recovery routine and seek out the opportunities presented by an evolving recession regime. It can be lucrative, but a pivot into a very different mode of brokerage.

Related article:

How to prepare for the REO resurgence