More homebuyers are taking a chance on adjustable-rate mortgages, hoping rates will fall, here’s how to think about that bet

With 30-year mortgage rates back above 7%, homebuyers are looking for relief wherever they can find it.

That increasingly includes adjustable-rate mortgages, or ARMs, which currently offer rates around 1 percentage point lower than a traditional 30-year fixed mortgage. ARMs accounted for 10.3% of mortgage applications in the week ending Oct. 2, up from 5.9% in the week ending Oct. 4, 2024, according to the Mortgage Bankers Association.

But ARMs also come with a trade-off: The lower rate is typically fixed for only the first five, seven or 10 years, after which the rate, and monthly payment, can reset periodically. If interest rates are higher when that introductory period ends, your monthly payment and interest costs could rise significantly.

The thinking among some homebuyers goes something like this: Take the lower rate an ARM offers today and give yourself five or seven years for broader rates to come back down. If they do, you may be able to refinance into a lower fixed rate or see your ARM adjust lower once its fixed period ends. That way, you get a discount now and potentially a lower rate later.

"An ARM can be a good choice if it is a strategic decision instead of, 'This is the only way that I can afford a mortgage,'" Hannah Jones, senior economist at Realtor.com , tells CNBC Make It. "If that's already going to be a stretch, then that means that you're going to be quite exposed when that fixed rate period ends."

If you're considering an ARM , here's how to weigh the potential savings against the risk, and what to look for before signing.

There's a reason most people stick with 30-year fixed mortgages: Your interest rate stays the same, even if rates go up. But if rates fall, you still have the option to refinance later into a new loan with a lower rate.

But with the cost of homeownership so high, it's easy to see why more buyers might be willing to consider an ARM.

"When the spread between a fixed-rate mortgage and an adjustable-rate mortgage is relatively large, it makes sense that more buyers would be drawn to that adjustable-rate mortgage when they could be saving $100, $200, $300 a month," Jones says.

With mortgages above 7%, some buyers may figure five or seven years is plenty of time for rates to come down, allowing them to refinance into a cheaper fixed-rate mortgage or simply pay a lower rate when the ARM adjusts.

For many borrowers, rates above 7% may feel unusually high. Before 2022, mortgage rates had spent roughly two decades below that level, according to Mortgage News Daily.

There are reasons to think rates could decline from here. Mortgage rates would likely ease if oil prices retreat, inflation continues to cool, tariffs are reduced or the labor market weakens enough to strengthen expectations for Federal Reserve rate cuts, Jones says.

But none of those outcomes are guaranteed, and borrowers should consider what would happen if rates move in the opposite direction, Jones says.

"The expectation is always that interest rates will cycle, but we've learned a good lesson that they don't necessarily cycle the way you want," says Melissa Cohn, mortgage industry veteran and regional vice president at William Raveis Mortgage.

That said, "the chances are still pretty good that we will see lower rates in the next year or two… but never say never, because things change and we have no control over them," she says.

That uncertainty matters when weighing the upfront savings of an ARM.

"I'd look at the lower rate as guaranteed savings during the fixed period, and a future refinance as potential upside, not the plan you need in order to make the mortgage work," says Arman Javaherian, CEO of homebuying platform Homa AI.

Although ARMs commonly have 30-year terms, the interest rate is typically fixed for only part of that time. A 5/6 ARM, for example, keeps the same rate for five years and can then adjust every six months based on changes in an underlying benchmark rate. A 7/6 ARM gives you seven years before the first adjustment.

And if that weren't enough numbers and slashes, ARMs also come with rate caps that limit how quickly and how far the rate can rise.

Take the common 2/1/5 cap structure, for example. That means your rate can rise by up to 2 percentage points at the first adjustment, 1 point at each adjustment after that and 5 points in total over the life of the loan.

A 5/6 ARM starting at 6.5% with 2/1/5 caps, then, could eventually reach 11.5%. But it wouldn't jump there immediately. At the first adjustment, the rate could go no higher than 8.5%.

Before choosing an ARM, ask your lender what your monthly payment could rise to under the loan's rate caps.

"Figure out what the highest payment can be over the life of the loan, and ask yourself if you're comfortable with that number," says Cohn.

Whatever type of mortgage you choose, don't assume you'll be able to refinance later to make the loan more affordable, Cohn says.

Mortgage rates may not fall far enough to make refinancing worthwhile. Even if they do, upfront costs can offset your savings. Refinancing typically costs 2% to 5% of the new loan amount, according to Bankrate . On a $300,000 loan, that's $6,000 to $15,000.

You'll also need to qualify for the new mortgage based on your finances at the time, just as you would when refinancing a fixed-rate loan.

A lot can change before you're ready to refinance. Your home's value could decline, your credit could worsen, your income could fall or you could take on additional debt, Cohn says. Before taking out an ARM, it can be useful to calculate how far rates would need to fall for the savings from refinancing to outweigh the closing costs.

"If you go out after you bought your home and you buy cars or take on a lot of other debt, it's quite possible that the mortgage you qualified for before, you no longer qualify for now," Cohn says.

For ARM borrowers, that's also why Cohn recommends choosing a fixed-rate introductory period that's longer than you think you'll need. Someone who expects to sell or refinance within three or four years might consider a seven-year ARM rather than a five-year ARM, for example.

"The rate is a little bit higher than the five-year, but it's going to give you that additional period of protection with the interest rate, and I think that's very important today," she says.

Ultimately, an ARM is a trade-off between savings you can get today and uncertainty you're taking on later.

"While an adjustable-rate mortgage can be a strategic, calculated decision, it's really worth weighing both ends of the spectrum. What could this mean if everything goes in my favor? But also, what could this mean if things do not go in my favor?" Jones says. "We cannot predict the future."

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