Risky Mortgages Could Lead to Foreclosure Spike

Homebuyers seeking out adjustable-rate mortgages in this high-rate environment could find themselves at an increased risk for foreclosure.

The Mortgage Bankers Association found that applications for 5/1 adjustable-rate mortgages (ARMs) climbed 32.5 percent in the week ending October 6 as loan rates fell to the mid-6 percent range.

Meanwhile, the total number of ARM applications surged 15 percent last week, and in what has been the highest percentage since November 2022, borrowers who were looking for an adjustable rate mortgage (ARM) made up 9.2 percent of the entire group.

Fixed mortgages, on the other hand, saw steady rate growth, to 7.67 percent from 7.53 percent.

"While most mortgage rates increased last week, rates on ARMs declined, leading to an increase in ARM volume and an increase in overall applications," MBA Deputy Chief Economist Joel Kan said in a statement. "The yield curve has become less inverted in recent weeks, and ARM pricing has certainly improved."

This could lead to a spike in foreclosures in the future as ARMs are generally far riskier than traditional 30-year fixed-rate mortgages. The reason is that while traditional mortgages will stay the same no matter the year, an ARM changes after the introductory period to reflect current rates.

Sometimes borrowers are planning for rates to drop after the introductory period, while other times they don't expect to own the home for long. Still, occasionally, homeowners are punished for choosing these riskier options when mortgage rates rise and they are forced to pay the higher amount.

Mortgage broker Rocke Andrews told Realtor.com that ARMs have increasingly become popular for first-time home buyers who may not be able to afford a house any other way.

"When the pricing is good, they are a great option," Andrews said. "If the upfront cost is not too high, then I expect more borrowers to start considering adjustable-rate mortgages."

Current mortgage rates are nearing 8 percent, meaning an ARM could be an ideal option for those looking to get their rates in the mid-6 percent range.

But of course there's no guarantee, meaning that foreclosure rates could climb in the next couple of years.

"The risk to the buyers is that eventually the rates will go up and they may not be able to afford the home," Andrews said. "But prices are going up so quickly that, if they wait, they may not be able to afford the home. This is a way to get into the home now and refinance later."

At around the time of the recession in 2008, a rise in ARMs was seen to lead to a high number of foreclosures. Among 8.37 million ARMs, one in eight, or 1.1 million, were estimated to end in foreclosure, according to a study from First American CoreLogic.

Altogether, fewer homebuyers are seeking out any type of mortgage because of the state of the housing market, which currently offers inflated home prices and an overall shortage for those looking for homes.

From last year, ARM applications declined by 34.2 percent, reflecting the continuing issues in the industry.