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Adjustable rate mortgages are back

ARI SHAPIRO, HOST:

With mortgage rates up sharply, a lot more homebuyers are turning to adjustable-rate loans. These can be more affordable - at least at first - but they come with a big risk - that your mortgage payment might go up a lot in the future. So how do you know if the risk is worth it? NPR's Chris Arnold explains.

CHRIS ARNOLD, BYLINE: Katrina Wooten is trying to buy a house near Gainesville, Fla.

KATRINA WOOTEN: We hate where we're living right now. It's a trailer. It's falling apart.

ARNOLD: Wooten has three kids, and these days, she has a good job as a nurse with the VA. So she saved up a down payment and signed a contract to buy a new home for about $375,000. The whole family was excited.

WOOTEN: So excited, especially my 14-year-old. You know, he's going to be out of my house probably in a few years, and he's never really had, like, a nice house to live in.

ARNOLD: But the house won't be finished getting built for a few months, and she hasn't locked in an interest rate on a mortgage. So if she were to get a mortgage today, the monthly payments would be hundreds of dollars higher than she budgeted for because rates have risen so much so quickly.

WOOTEN: I mean, I was having panic attacks over it because, of course, this is such a big deal for me.

ARNOLD: And now she doesn't know if she'll be able to afford the home. She thought about an adjustable-rate loan, but...

WOOTEN: Adjustable-rate mortgages scare me for sure.

ARNOLD: They're scary because they can adjust to a higher payment than you can afford. But with mortgage rates rising so much, the share of people applying to get adjustable-rate loans is the highest it's been in 15 years. These loans can be tantalizing. They start out with a lower interest rate - sometimes a full percentage point lower. Holden Lewis writes about mortgages for the personal finance site NerdWallet.

HOLDEN LEWIS: A percentage point can make a really, really big difference in that monthly payment. And so they grasped for that rescue ring - an adjustable-rate mortgage.

ARNOLD: And Lewis says for some homebuyers, that's OK. He says loans today are not the crazy adjustable mortgages that led to the housing crash. Those are illegal now. These days, the loans are usually fixed for either five, seven or 10 years, and then they adjust to wherever rates are in the market. But they definitely have more risk than fixed-rate loans. The whole reason they have a lower rate is that the bank or lender is handing off some of the risk of interest rates rising in the future to you. The lower rate is, in effect, your compensation for taking on that risk.

LEWIS: When you get a fixed-rate loan, if mortgage rates rise after that, that's the lender's problem. If you get an adjustable-rate loan and mortgage rates rise, that's your problem.

ARNOLD: So the question becomes, quite literally, can you afford to take on that added risk? Nathan Lindstrom is buying a house in Phoenix, Ariz.

NATHAN LINDSTROM: We are locked in with an adjustable-rate 10-year arm at 4%.

ARNOLD: Lindstrom works in finance in the health care industry, and his loan won't adjust for 10 years, but at that point, if interest rates are really high, he has a plan - and he wouldn't really be in trouble.

LINDSTROM: My wife and I would be able to sell off some of our investments to almost completely pay off the house.

ARNOLD: So if you can afford to pay off a big chunk of your mortgage, you have a way out if rates go up a lot. But people without a big income and much savings - many probably can't afford to take on the risk of an adjustable-rate loan. Katrina Wooten in Florida doesn't want to get stuck with a mortgage that she can't afford.

WOOTEN: I did grow up poor, and I was the first one in my family to go to college and graduate. And I'm really trying to not screw myself or my family over to not take that big of a risk because I absolutely don't have any family to turn to if this all falls apart. This is all on me. And it's got to work out.

ARNOLD: Wooten says she'd rather take on a higher interest rate in a fixed-rate loan, even if it means living really frugally for a while, and then hope rates fall again before too long so she can refinance. Chris Arnold, NPR News. Transcript provided by NPR, Copyright NPR.

NPR correspondent Chris Arnold is based in Boston. His reports are heard regularly on NPR's award-winning newsmagazines Morning Edition, All Things Considered, and Weekend Edition. He joined NPR in 1996 and was based in San Francisco before moving to Boston in 2001.
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