Why 8% of Homebuyers Bet on ARMs in a Fixed-Rate World

The average rate on 5-year adjustable-rate mortgages (ARMs) in the U.S. stood at 6.78% as of Sept. 9, 2025, according to data from Zillow, a leading real estate marketplace. This rate reflects a stable trend compared to the previous business day, with the 7-year ARM rate at 6.38%. These figures underscore continued interest in ARM products, despite the dominance of fixed-rate mortgages in the market. While fixed-rate mortgages remain the preferred option for 92% of U.S. households, ARMs offer unique advantages for certain segments of homebuyers and investors.

Adjustable-rate mortgages are structured with an initial fixed interest rate period followed by periodic adjustments based on market conditions. The most common structures include the 5/1 ARM (fixed for five years, then adjusts annually), 7/1 ARM, and 10/1 ARM. The initial lower rates of ARMs can be particularly attractive for borrowers who plan to sell or refinance before the adjustment period begins. Additionally, ARMs may provide cost savings for buyers in a high-interest-rate environment, as they typically offer a lower initial rate compared to fixed-rate mortgages.

The functioning of ARMs is closely tied to benchmark rates such as the Secured Overnight Financing Rate (SOFR). Lenders set ARM interest rates by adding a fixed margin to the SOFR, which typically ranges from 2% to 3.5%. Rate caps also play a critical role in mitigating risk for borrowers. These caps limit how much the interest rate can increase during specific periods or over the life of the loan. For example, the lifetime cap may restrict the rate from rising more than 5 percentage points above the initial rate. These mechanisms provide some predictability for borrowers, though they do not eliminate the inherent volatility of ARM loans.

The decision to opt for an ARM is often influenced by personal financial goals and market conditions. A recent survey highlights that ARMs can be particularly beneficial for short-term homeowners, real estate investors, and buyers seeking lower initial costs in a high-rate environment. For instance, investors may utilize ARMs to secure properties with low initial rates, plan to adjust rents or sell before the adjustment period begins, or take advantage of potential refinancing opportunities. Similarly, first-time homebuyers who expect future income growth or plan to move within a few years may find ARMs a strategic option, though they also face the risk of rising payments if market conditions shift.

The economic impact of ARMs extends beyond individual borrower decisions. Recent academic research highlights how ARM prevalence and the distribution of liquidity-constrained households influence monetary policy transmission in the Euro Area. The interaction between ARM exposure and household financial behavior has been found to significantly affect consumption responses to interest rate changes. For instance, liquidity-constrained households with adjustable-rate mortgages are more likely to reduce consumption in response to rate hikes, compared to wealthier households with greater financial buffers. This dynamic underscores the importance of understanding regional ARM distribution and household financial profiles for central banks seeking to assess the effectiveness of policy measures.

As the housing market continues to evolve, ARMs remain a viable option for certain segments of borrowers, particularly those with short-term housing plans or those seeking flexibility in a high-rate environment. However, the complexity of ARM terms and the potential for payment variability necessitate careful financial planning and risk assessment. Borrowers considering an ARM should evaluate their long-term financial goals, rate cap structures, and the potential for refinancing to mitigate the risks associated with interest rate fluctuations. With the Federal Reserve maintaining a cautious stance on rate adjustments in 2025, the appeal of ARMs may remain strong for those seeking lower initial costs and flexibility in a dynamic mortgage market.

Source: [1] Current ARM mortgage rates report for Sept. 8, 2025 (https://fortune.com/article/current-arm-mortgage-rates-09-08-2025/) [2] Current ARM mortgage rates report for Sept. 9, 2025 (https://fortune.com/article/current-arm-mortgage-rates-09-09-2025/) [3] Housing Markets and Monetary Policy Transmission - e-axes (https://e-axes.com/housing-markets-and-monetary-policy-transmission-evidence-from-uk-and-eu/)