Homebuyers desperate to get a mortgage are lining up for the same risky bet that helped cause the 2008 housing crash
- Adjustable-rate mortgages are making a comeback despite their role in the 2008 housing crash.
- LendingTree says the number of ARMs offered to borrowers has more than tripled since 2021.
A growing number of borrowers are turning to a type of mortgage that helped cause the 2008 housing crash as interest rates rise and affordability sinks.
Data from mortgage marketplace LendingTree shows the number of adjustable-rate mortgages offered to its users increased by 230% from the first half of 2021 to the first half of this year.
Also known as ARMs, these loans have an interest rate that adjusts over time depending on the fluctuation of market rates. They're less predictable than fixed-mortgages as they tend to change periodically, but are attractive to borrowers as they initially have lower interest rate payments.
With more borrowers struggling to afford homeownership, it's no surprise they are making a comeback. However, Jacob Channel, the senior economist at LendingTree, says Americans should be weary about their resurgence.
"It is very important for both lenders and borrowers to know the risks associated with adjustable-rate mortgages and to not become too cavalier about issuing or seeking out these types of loans," he told Insider.
That's because ARMs played a key role in the housing bubble that gave rise to the 2008 housing crash. Leading up to the implosion, many subprime lenders enticed borrowers with interest-only ARMs — an adjustable mortgage that initially only requires interest payments rather than including both principal and interest. However, when rates spiked, many borrowers could no longer afford the payments on their loans. This triggered a foreclosure crisis among homeowners, as well as a credit crisis among the investors who owned bonds backed by these underwater mortgages — it also birthed a global recession.
Although lending standards are much tighter in 2022, there has been an increase in the amount of borrowers with risky credit scores being offered ARMs.
According to LendingTree, while the share of ARMs offered to borrowers with a credit score of 680 or higher decreased by 21.32 percentage points between the first half of 2021 and the first half of 2022, the share of ARMs offered to borrowers with credit scores of 620 to 679 increased by 19.98 percentage points. For those with a credit score of 619 or below, the share increased by 1.34 percentage points.
If more borrowers with fair and even poor credit receive ARMs, Channel says it could result in bigger problems down the line.
"While the findings of our study are not necessarily a cause for concern in the immediate future, if the trend of ARMs becoming more common and being offered to borrowers with lower scores continues, then ARMs may once again contribute to a future housing crisis," he said.
Indeed, borrowers with lower credit scores are more sensitive to rate hikes. Data from TransUnion shows that as inflation soars, more borrowers with low FICO scores are defaulting on their loans. Although borrowers who recently got an ARMs are unlikely to be impacted by the Feds' recent rate hikes, those who got an adjustable-rate mortgage five or more years ago may see their monthly payment increase by hundreds of dollars.
"Keep in mind that a rate increase of even two percentage points can increase a person's monthly mortgage payment by hundreds of dollars — depending on factors like their loan amount and starting rate," Channel said, adding that a rate hike may increase some ARM borrowers' risk of defaulting on their loans.
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