Bay Area home prices are falling fast, but interest rates are on the rise — meaning that for many, the home of their dreams is now out of their price range.
But some buyers have found a solution: adjustable-rate mortgages, which guarantee lower monthly payments for the initial years of a home loan.
While adjustable loans are riskier than traditional fixed-rate mortgages, real estate experts say most buyers opting for them are in good financial position and unlikely to default should their rates spike. Plus stricter regulations in the wake the 2008 housing crash afford home seekers more protection from predatory lending.
“Pretty much every buyer that I’ve worked with after March this year went with an (adjustable-rate mortgage) instead of a fixed,” said Fremont real estate agent Sunil Sethi.
Nationwide, a recent Zillow report found that 12% of all mortgage applications in July were for adjustable loans, the highest share since August 2007.
Currently, borrowers can take advantage of an average 4.36% interest rate for a conforming 5/1 adjustable mortgage — where the rate stays the same for five years before being adjusted each year for the rest of the term of the loan. That’s compared to a 5.55% rate for a conforming 30-year fixed mortgage, according to Freddie Mac.
Even that seemingly modest difference can result in monthly payments that are hundreds or even thousands of dollars cheaper, depending on the price of a home. But once the fixed period of adjustable mortgages end, rates — which are tied to various economic indicators — can jump suddenly.
The hope often is that fixed rates will have fallen by then so homeowners can refinance.
Nicole Bachaud, a Zillow senior economist, said federal mortgage data shows homeowners taking out adjustable loans tend to have higher incomes and make larger down payments and in turn should be able to shoulder that risk.
“These folks are a lot more financially stable — there’s less chance of a negative outcome because of their financial well being,” she said.
Bachaud added that caps on rate adjustments and other restrictions on risky lending following the housing meltdown 14 years ago should ease any fears the increase in adjustable mortgages is a harbinger of a coming market crash.
Still rising mortgage rates — now double the historic-low sub-3% rates available during the depths of the pandemic — have squeezed many buyers out of the market as the Federal Reserve has raised the cost of borrowing in recent months in a bid to slow runaway inflation. And that buyer pullback has cooled the Bay Area’s record-setting pandemic real estate market in recent months.
In July, the median price of existing single-family homes in the Bay Area fell 6% from June to $1.28 million, according to the latest data from real estate analytics firm CoreLogic.
San Mateo County — the most expensive market in the five-county Bay Area — saw the median price drop 8% from just under $1.83 million in May to $1.68 million in June. San Francisco fell from $1.8 million to $1.63 million, Santa Clara dropped from $1.74 million to $1.62 million, Alameda dipped from $1.32 million to $1.25 million, and Contra Costa — the most affordable of the core Bay Area counties — went from $900,000 to $860,000.
Sethi, the Fremont real estate agent, said many of the homebuyers taking out adjustable mortgages are betting that larger trend will eventually reverse.
“Their thought process is whatever is happening right now in the economy is going to change, and when it changes, rates are going to come down, and they can refinance when it happens,” he said.
San Mateo County agent Jeff Lamont has also seen more buyers turn to five-year and seven-year adjustable-rate mortgages as rising interest rates have tamped down their purchasing power.
For some buyers, he said, the loans are attractive either because they’re purchasing a starter home or they anticipate moving again soon.
“One school of thought,” Lamont said, “is why pay 30-year fixed rate mortgage money if you’re only going to be there 5 to 7 years?”