Lower Mortgage Rates Spark Interest in ARMs Giving Borrowers ‘Breathing Room’

The Federal Reserve cutting interest rates again a quarter of a point is providing a boost to the housing market, but it's not necessarily enough to push people to make a home purchase.

Mortgage interest rates are at 6.17% for the week ending Oct. 30, according to Freddie Mac. This is the fourth consecutive week of decreases.

Though the Fed's rate cut doesn't directly set mortgage rates, it can influence them.

The National Association of Realtors® explains that mortgage rates generally track Treasury yields, but loans like adjustable-rate mortgages (ARMs) may see a more direct impact from the Fed's latest moves.

Potential buyers who want to become homeowners are looking at ways to save money. So, instead of the traditional 30-year fixed mortgage, people are looking at ARMs as a way to save some money on their monthly payments.

"For the first time in a number of years, we are seeing much lower starting interest rates with ARM loans," Michael Pearson, senior vice president of business development at A&D Mortgage, tells Realtor.com®.

"Borrowers who wanted the lowest possible interest rates are taking advantage. Additionally, the common wisdom is that interest rates will continue to dip lower, slowly over the next couple of years. So although ARMs offer only short-term fixed interest rates, there may be more opportunities to lock into long-term lower rates in the coming years."

ARMs made up about 10% of all mortgage applications in September—the highest level in nearly two years, according to the Mortgage Bankers Association.

How do ARMs work?

Adjustable-rate mortgages, also known as variable-rate mortgages, have an interest rate that changes periodically.

ARM loans usually have a lower fixed rate for a certain number of years, before that rate adjusts based on interest rates.

The ARM rate is currently almost a percentage point lower than the 30-year fixed rate, according to the MBA’s data.

"Ideal candidates for an ARM are those who are savvy with their finances and have a bit of a game plan for their future," Derrick Strauss with Planet Home Lending in Denver tells Realtor.com. "The initial lower payments of an ARM may make sense because they'll save money before they move on."

ARMs are becoming more popular because they provide some immediate savings.

A 5/1 ARM averaged 5.66% in September, nearly a full percentage point below the 30-year fixed-rate average. On a $400,000 loan, that could translate to about $200 per month in savings, Joel Kan, MBA’s vice president and deputy chief economist, told CNBC.

But if a borrower doesn't pay attention to the length of the loan, it could end up costing more, mortgage experts warn.

"Choosing between an adjustable-rate mortgage and a fixed-rate mortgage is kind of like deciding whether you want to ride a roller coaster or a merry-go-round," says Frank Brandt with Planet Home Lending in Texas. "With an ARM, your monthly house payment typically starts off lower than a fixed-rate loan, but it can go up or down depending on interest rates."

"If rates go up, so does your monthly payment," Brandt tells Realtor.com. "But if they drop, you're in luck because your payment goes down."

"If you expect a decent salary bump in the coming years, starting with lower payments could be strategic," says Strauss. "It gives you breathing room now, and when your income increases, you'll be more comfortable handling potentially higher payments if interest rates go up."