As we head toward Memorial Day and then the summer, Orion’s brokers know that 30-year mortgage rates have increased. The FDIC is overseeing the selling of large amounts of securities backed by mortgages, which is weighing on prices and nudging rates higher, but there is also evidence that the U.S. economy is doing better than many people thought it would. Brokers know that this tends to also increase rates.

With the move higher in mortgage rates in May, Orion is seeing renewed interest in adjustable-rate mortgages, or ARMs, despite short-term rates being somewhat high. Orion’s ARM program underwriting ensures that borrowers meet “Ability toRepay” (ATR) requirements, and they are perfectly fine and a great option for many borrowers.

As a reminder, most ARMs are “intermediate” adjustable mortgages that are fixed fora certain period of time and then adjust after that. A 5/1 ARM has a fixed interest rate for the first five years and then switches to an adjustable interest rate for the remainder of its term; A 3/1 ARM is fixed for three years, a 7/1 is fixed for seven. An ARM has a fixed rate for the first severalyears of the loan term that’s often called the “teaser rate” because it’s lower than any comparable rate you can get for a fixed-rate mortgage. Rates may befixed for 7 or 10 years, although the 5-year ARM is a very common option.

Once the fixed-rate portion of the term is over, the ARM adjusts up or down based on current market rates of its index, subject to caps governing how much the rate can go up in any particular adjustment. Typically, the adjustment happens once per year and the new rate is calculated by adding an index number to a margin specified in your client’s mortgage documentation. Common indexes used for ARMs,once they adjust, include the Secured Overnight Financing Rate (SOFR), the Costof Funds Index (COFI) and the Constant Maturity Treasuries (CMT). And each time your client’s interest rate changes, the payment is recalculated so that their loanis paid off by the end of the term.

An ARM may have “5/2/5 caps.” What does that mean? A 5/1 ARM with a 5/2/5 cap structure means that for the first seven years the rate is unchanged, but on the eighth year the rate can increase by a maximum of 5 percentage points (the first"5") above the initial interest rate. Every year there after, your client’s rate can adjust a maximum of 2 percentage points (the second number,"2"), but the interest rate can never increase more than 5 percentage points (the last number, "5") over the life of the loan. Other than the margin in the loan documentation, there’s no limiting factor to how muchyour client’s interest rate could adjust down in any particular year if interest rates have moved lower.

Because the interest rate can change in the future, an ARM is structured so that yourclient can get a lower interest rate for the first several years of the loan than they would if the client were to go with a comparable fixed rate. If your borrower knows that they’re in a starter home and will be moving in a few years, they might move before the interest rate ever adjusts.

Orion’s management is not in the business of predicting interest rates, but many believe that rates may be lower later in 2023. As interest rates go down, there tends to be a narrowing of the yield curve. This gets a little bit technical, but basically the yield curve deals with the difference between fixed- and adjustable-rate mortgages. If your client is saving a significant amount on the front end of the loan by going with an ARM, it can be worth it. If the differenceis 10 basis points (10 hundredths of a percentage point), not so much. Orion’s AEs know about our adjustable programs, so ask!

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