A workman wears a hard hat at a building site in Portland on Friday, May 6, 2022. Credit: Troy R. Bennett / BDN

Home buyers are flocking to adjustable mortgages with the rates for conventional mortgages continuing to rise.

The overheated real estate market the past couple years was fueled in part by interest rates below 3 percent for 30-year fixed-rate mortgages. Those rates began to rise sharply in February and are above 5 percent now, after the Federal Reserve raised interest rates last Wednesday by half a percentage point to stem inflation.

Adjustable-rate mortgages, known as ARMs, offer lower initial fixed rates. They are running about one percentage point lower than fixed rates now and are attracting mortgage applicants who could potentially borrow more money because of the lower rate. They could bring a previously unaffordable home within reach for those who qualify.

ARMs developed a bad reputation for their role in the 2008 housing and stock market crashes. Lenders offered more products to people with lower credit ratings and savings than typically required, including interest-only ARMs that still weren’t affordable to buyers. ARMs now include qualified mortgage standards to better screen applicants.

Large Maine banks have been seeing more applicants turn to ARMs in recent months. Bangor Savings Bank had a 19 percent increase in the number of applications for those loans and a 16 percent increase in the amount borrowed since January, Laura Johnson, senior vice president and director of mortgage sales and fulfillment at the bank, said.

Johnson said ARMS are a bit more risky than a 30-year fixed-rate loan because the rates and payments can rise over the life of the loan.

But they are good for people who plan to sell their home before the fixed period ends. The loans have been popular in the past when mortgage rates rose, although 30-year fixed rate loans dominate the market.

ARMs are 30-year mortgages with a lower fixed rate for a shorter amount of time, usually five, seven or 10 years. After that, the rate adjusts to the market rate, meaning they can go up or down every year or every six months, depending on loan terms. Many people refinance when the fixed period ends.

Nationwide, ARMs accounted for 10.8 percent of total home applications last week, up from 3.1 percent at the beginning of the year and the largest share since 2008, according to the Mortgage Bankers Association.

Camden National Bank also has seen ARM applications rise since January, with home buyers looking for alternatives. The most popular ARM at the bank is the seven-year fixed term that resets every year thereafter, Trish Rose, executive vice president of retail and mortgage banking at Camden National, said.

If someone takes out a $300,000, 30-year fixed mortgage with a 20 percent down payment and no points, the interest rate would be 5.375 percent, or $1,680 per month in principle and interest, Rose said.

A 7:1 ARM, which is fixed for the first seven years, would have an interest rate of 4.25 percent and be $1,476 per month. That payment is $204 per month less and an additional $345,000 more in potential buying power, she said.

“The ARM is a benefit to someone who doesn’t expect to stay in the property,” she said.

The various ARMs require different qualifications by underwriters, so those taking out loans should carefully consider the terms. In some cases, applicants could qualify for less of a mortgage because of underwriting requirements, Jaime Frederes, senior vice president and director of residential lending at Bar Harbor Bank & Trust, said.

Still, he expects to see ARM applications rise.

“If fixed rates continue to rise along with home prices, we expect that a higher percentage of homes will be financed with ARM products than over the last few years,” Frederes said.

Correction: A previous version of this story had an incorrect percentage for the increase in loan amount for adjustable-rate mortgages at Bangor Savings Bank.