The average adjustable rate mortgage (ARM) rate on a 5/1 ARM averaged 3.99% in July 2019. This is down slightly from a year earlier when the rate was 4.12%.

As of July 2019, the average FRM rate is actually lower than the average ARM rate, making these riskier mortgage products even less appealing. As interest rates have fallen back in 2019, the spread between the ARM and FRM rates has diminished and now inverted. Therefore, ARM use will remain extremely low over the next couple of years, as the Fed will work to keep interest rates on FRMs low as the economy slows and a recession arrives, projected to hit in mid-2020.

Lower fixed rate mortgage (FRM) rates make ARMs less alluring to buyers. Further, long-term homebuyers still prefer the security of an FRM rate. Thus, ARM over-use will not an issue in 2019 or 2020. It is up to real estate professionals to guide homebuyers to the right mortgage product for their situation and investment experience.

Updated August 5, 2019. Original copy released April 2016.

Chart update 08/05/19

Jul 2018 Jun 2019 Jul 2018
Average 5/1 ARM rate 3.99% 3.85% 4.12%

The chart above shows the average interest rate for the first five years after origination on a 5/1 ARM, the most popular type of ARM for homebuyers. After the initial five-year period, the ARM rate is adjusted annually based on an index figure.

ARM rates yesterday, today

The adjustable rate mortgage (ARM) rate was legalized in 1980 through passage of the Depository Institutions Deregulation and Monetary Control Act of 1980.

Unlike a fixed rate mortgage (FRM), which guarantees a set rate over the life of the mortgage, ARMs shift inflationary and economic risk from the mortgage holder to the borrower by allowing mortgage rates to “float” with the market.

The rate is tied to a specified index that varies based on market factors. The initial interest rate before adjustments is called the teaser rate. On adjustment, the new ARM rate equals the yield on the index specified in the ARM note plus the lender’s profit margin. Common indices used to periodically adjust the ARM rate include the:

One of the interest rates with the most influence on ARM rates is the Federal Funds rate, which is the target short-term borrowing rate the Federal Reserve (the Fed) sets for banks to lend to each other. From 2009 through December 2015, the Fed’s target rate was 0% – 0.25%, essentially zero. Then, at the end of 2015, the Fed increased the target rate to 0.25% – 0.5% to prepare for an expanding economy.

The Fed continued its expansionary agenda through July 2019, when it dropped rates for the first time since the lead-up to the 2008 recession. In anticipation, the ARM rate has dropped through much of 2019, though not as quickly as FRM rates, which is now lower than the average ARM rate.

ARM use: a danger for the housing market

The average ARM rate peaked in 2006 at just over 6%. At that time, three out of every four mortgages originated in California were ARMs. This proved disastrous for then-homebuyers.

ARMs are far riskier mortgage products than FRMs. When ARM rates reset, the higher payment often results in payment shock, leaving many homeowners simply unable to pay.

Many ARM users plan to refinance into an FRM before their ARM resets, but high unemployment rates made this impossible for many homeowners during the recession. This situation is partly to blame for the 2008-2009 foreclosure crisis.

The epic catastrophe caused by ARMs helped steer homebuyers away from the mortgage product in the years following the recession. Stricter underwriting standards, which granted the mortgage with the reset rate in mind rather than the teaser rate, also helped keep ARM use in check. Still, ARM use inched up when the average ARM rate was at its bottom in 2013. By 2014, roughly out of every six mortgage originations was an ARM, according to Freddie Mac. Historically, this ratio is considered about average for a healthy market.

ARM use has since cooled significantly, due to less demand since FRMs — less risky and easier to qualify for — have seen lower, more desirable rates.

The future of the ARM

What will the ARM chart above look like in the coming months and years?

Aside from short-term action, the ARM rate will likely stay near its present low level through 2021. This is because the Federal Funds rate — which influences the indices to which most ARMs are tied — will be held down as the Fed prepares for the next recession.

However, the next two-to-three decades will see a gradual rise in rates. The average ARM rate also follows the historical 60-year rate cycle, which reached its bottom in 2012. Now, we expect rates to rise over the next two-to-three decades, as in the 1980s through 2012. This long-term rise will resume in the years following the next recession, expected to arrive in 2020.