CNN —
Jennifer Hernandez was stunned last year when she received notice that her mortgage payment on her Houston home would increase by about $2,000 a month.
In 2016, Hernandez refinanced her mortgage using an adjustable-rate mortgage, which offered a lower initial interest rate for a set period of time.
Unlike more typical fixed-rate mortgages, ARMs can offer temporary relief to homebuyers who want to avoid paying high mortgage interest rates, but they also come with risks: After a fixed introductory period, usually five, seven, or 10 years, the interest rate on an ARM loan adjusts periodically based on current market conditions.
That means that when mortgage rates rise, many ARM loan holders like Hernandez will get the unpleasant shock of a much larger monthly mortgage payment. For thousands of Americans like Hernandez who took out ARM loans five years ago, before interest rates soared to their highest levels in 40 years, that shock will come this year.
As mortgage rates remain high and fuel the most expensive housing market in decades, ARMs are gaining popularity despite their drawbacks.
According to data from Intercontinental Exchange, a global technology and data provider, 1.7 million homeowners have purchased homes using adjustable-rate mortgages since 2019. Many buyers who purchased five-year adjustable-rate mortgages, one of the most popular products, will move into significantly higher monthly payments this year.
The fixed periods on these ARMs have already been reset for 328,000 homeowners, with another 102,000 loans scheduled to reset over the next 12 months, according to ICE.
ARM loans gained a bad reputation after the subprime mortgage crisis of 2007 and 2008, when many homebuyers found themselves unable to make their monthly mortgage payments when interest rates were reset.
While the share of homebuyers choosing ARMs has never returned to pre-2008 levels, the share of homebuyers using ARM loans has doubled over the past four years, according to the Mortgage Bankers Association.
Lorianne Jones, a Southern California mortgage consultant, told CNN that ARMs may make sense for homebuyers who can tolerate the risk of rising interest rates, or for those who plan to move or refinance before the fixed-rate period ends.
But it's important to pay close attention to the details when choosing an ARM, or things could get tricky fast.
Hernandez, who is also a loan officer, remembered the terms of his $1.1 million loan incorrectly: He got a 7/1 loan instead of a 10/1 ARM, which would have a fixed rate for the first 10 years and then reset annually.
“It all happened so suddenly,” she says. “Life gets busy. For the last seven years I've been busy raising my children and working.”
Last October, Hernandez's mortgage interest rate increased by 2 percentage points to 5.125%, the maximum allowed in the first adjustment year under the terms of her loan.
Most ARM loans have interest rate caps to prevent costs from getting out of control. Hernandez said the cap on her ARM was 8.125 percent, 5 percentage points higher than her original fixed rate.
For Hernandez, refinancing her loan didn't make much sense as long as her 30-year fixed mortgage rate remained higher than the new adjustable rate, but she thinks her monthly payments will likely be even higher come October.
“It's been going well so far, but now I have to figure out how to make it work again in October,” she said. “It's stressful to worry.”
Andrew Marquis, a loan officer in Lexington, Massachusetts, said he's seen a dramatic increase in applications for ARM loans recently. He said homebuyers are increasingly confident that the Federal Reserve will lower interest rates in the next few years, giving them time to refinance their loans before their ARMs' fixed periods end. While the Fed doesn't directly set mortgage rates, its actions affect interest rates. This year, the Fed has signaled it may cut its benchmark interest rate once.
“I would say that of the jumbo loans that we do, probably 40 percent are ARM loans,” Marquis said, referring to loan amounts over $766,000.
Marquis said ARM loans may be worth it for people with a higher risk tolerance.
“If you can save 0.5% on a seven-year adjustable rate loan compared to a 30-year fixed rate loan, that could save you hundreds of dollars each month,” he said.
Interest rates can be unpredictable, and although Hernandez was able to save money during the first seven years of the loan, she said that if she could do it over again, she wouldn't have chosen an adjustable-rate mortgage in 2016.
“I don't feel good about this increased payment,” she said. “I'm just hoping that when the October adjustment comes around, interest rates will be a little lower.”