A Farewell to ARMs? Three Regimes of Adjustable Rate Mortgages

Posted: 23 Oct 2015

See all articles by Frank P. Stafford

Frank P. Stafford

University of Michigan at Ann Arbor - Department of Economics

Bing Chen

Institute for Social Research

Date Written: October 22, 2015


Adjustable rate mortgages (ARMs) made a dramatic entry into the U.S. mortgage market subsequent to the passage of the GARN - St. Germain Depository Institutions Reform Act of 1982. By the mid 1990’s over 20 percent of first mortgages were adjustable and were used across a wide range of urban market types. Going forward to 2007 the percent of families with an ARM as a first mortgage had declined to 11% and the use of ARM’s was often then described as a tool for affordability - since the rates are commonly lower than for a fixed rate mortgage for a given repayment risk class of borrower. By 2013 the percent of ARMs as a first mortgage had fallen still further to just under 9%, and the use of a second mortgage had fallen as well. From the supply side the longer run attractiveness of ARMs was reduced by extensive securitization, allowing lenders to avoid correlated risk in local housing markets. Moreover, with the overall decline in mortgage rates in the context of zero lower bound conditions and low expected inflation, the spread between fixed and adjustable rates narrowed, making the ‘affordability’ component to ARM far less significant, though this dimension appears to continue to apply to African-American families Favorable economic conditions induce a demand for mortgages, especially by higher risk borrowers, and transactions occur at higher rates. A changing composition of the mortgage market emerges with a diverse set of borrowers actively using ARMs. Data from the Panel Study of Income Dynamics (PSID) for 1996, 2007 and 2013 are used to study borrowing decisions. Panel analysis confirms effects of education, non-housing wealth, expected duration at the current residence, and early financial experience in reliance on ARM mortgages.

Keywords: Consumption, Liquidity Constraints, Housing Demand, Mortgages

JEL Classification: G1, E21, R21

Suggested Citation

Stafford, Frank P. and Chen, Bing, A Farewell to ARMs? Three Regimes of Adjustable Rate Mortgages (October 22, 2015). Available at SSRN: https://ssrn.com/abstract=2678209

Frank P. Stafford (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

Bing Chen

Institute for Social Research ( email )

Ann Arbor, MI
United States

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