Help me save money on a mortgage.

November 20, 2008 5:24 PM

Mortgage filter: is there any reason I shouldn't get a 5/1 ARM at a slightly lower interest rate than the 30-year fixed option?

Asking for Dad.

I am buying a $247,000 foreclosed townhouse in Houston, TX with $50,000 down. I am financing $197,000 and currently have the following offers for mortgages (closing date is December 3rd, so I don't have much time):

A 5/1 ARM with an interest rate of 5.25% through ING direct. They have relatively few fees ($3,000 or so closing costs, no escrow, etc.), but unfortunately I do not have a crystal ball and don't know what interests rates will be in five years. (Current plans are for us to live in the new house for longer than five years.)

A 30 year fixed-rate mortgage at 5.625% with a local broker. My payments with the fixed-rate mortgages will be approximately $50-60 more a month, adding up to about $3,000 over five years. The broker has not been particularly upfront about fees (they keep changing on a daily basis), but it this loan will be more expensive than through ING Direct. My real estate agents says that I should go for the fixed-rate mortgage if I don't mind paying an extra $60 a month for the security of a low interest rate.

Hive mind, which option should I choose? Any additional advice when choosing a mortgage is also welcome, since I have never bought a home before.

posted by halogen to work & money (19 comments total)

I would opt for door #3 - a fixed rate mortgage from a broker who is up front about the fees.
posted by altcountryman at 5:35 PM on November 20, 2008

Just spoke with the broker: it seems that the fees for the fixed-rate would be approximately $2,000 (as opposed to $3,000 for the ARM).
posted by halogen at 5:36 PM on November 20, 2008

For me, the security of knowing what my monthly mortgage payment was going to be for the next thirty years was all I needed to know ARM vs fixed.

Additionally, my home owner's insurance and property taxes are paid through an escrow. That's two fewer bills I have to manage.
posted by wg at 5:50 PM on November 20, 2008

er, know about ARM
posted by wg at 5:51 PM on November 20, 2008

Is this a trick question?

I may well be betraying a fundamental lack of understanding of the mortgage crisis, but didn't a lot of townhouses become foreclosed townhouses precisely because people got adjustable rate mortgages and counted on the fact that prices would go up enough that they could have enough equity to refinance before their rates adjusted?

Why would you (or your dad) want to risk perpetuating that cycle?

Buy a home you like at a fixed cost that you can afford, and don't place bets on what the market is going to be like in five years.
posted by dersins at 5:55 PM on November 20, 2008

Nthing the above. The ONLY advantage to the ARM is the slightly lower payment, but the risk involved can't be overstated. Look around at people being forced out of their homes because they can't afford their payments after adjustment.

The rates now are very, very close to historic lows. Where else could they possibly go but up? If you can lock in a < 6 percent for 30 years? Do. It.
posted by griffey at 6:20 PM on November 20, 2008

Side question - can ARM rates go down? If lending rates go down for the next two or three years, would an adjustable ARM go down as well?
posted by zippy at 6:24 PM on November 20, 2008

... adjustable ARM go down ...
posted by zippy at 6:24 PM on November 20, 2008

i'm a big fan of knowing what my mortgage payment will be. and thus i've been a big fan of conventional fixed rate mortgages.
posted by rmd1023 at 6:42 PM on November 20, 2008

Mortgage rates while not that low compared to say 2006, are at historical lows if you look at data going back more than 5 years.

You are more likely to see your ARM go up to 6.25%.. 7.25%.. 8.25% or more, than you are ever seeing mortgages at 4.25% again.

Mortgage rates usually track treasury yields, plus a risk premium.
TREASURY YIELDS HIT RECORD LOW was flashing all over the Bloomberg Terminal screen today...

30 year mortgage rate history
posted by gomess at 7:16 PM on November 20, 2008

Disclaimer: I am not a mortgage broker or expert. Generally speaking, people didn't lose their mortgages by buying standard ARMs. They lost their mortgages by buying interest only ARMs, where they didn't pay any principal for the first few years of the loan. These people often got loans where the interest payment was all they could afford. When the interest-only part of the loan expired, people saw their monthly payments spike by 30% to 50% when the loan principal was added to their monthly payment. They couldn't afford the new payment and lost their homes.

You would get a regular ARM for a couple reasons:
* You're willing to bet that interest rates will be lower at the end of the adjustable rate phase of the loan, which in your case is five years. I can assure you that interest rates WILL NOT be lower in five years than they are today.
* You need the little bit of extra money you'll save with an ARM and figure your income will increase enough to cover the costs when the rate increases in five years. The difference between the adjustable and fixed mortgage rates aren't enough for this to make sense today. In other words, if you can't afford the extra $50 per month today, you shouldn't be getting the loan.

You need to watch out for a couple things.
* There may not be a maximum interest rate on your loan. The 1980's saw mortgage rates in the teens. It's possible, though not likely, that you'll go from 5.25% now to 15.25% in five years. This would result in a tremendous increase in your monthly payment.
* Some ARMs have a maximum rate (i.e. current rate plus 5%) a maximum starting rate in five years (so the loan couldn't immediately go to 15.25%) and a maximum rate increase per year (so the loan would go to 15.25% over a number o years). Again, 15.25% is an unlikely worst-case scenario, but something you should consider when thinking about whether to take the ARM.


Bottom line - a 5.625% fixed rate mortgage is near the lowest rate available since 1971. You'd be nuts to bet 50 bucks a month in savings on rates being lower in five years.

I'd also recommend getting several quotes, especially since your broker doesn't seem to be up front about fees.
posted by cnc at 7:35 PM on November 20, 2008 [3 favorites has favorites]

I did this five years ago. I got a fixed-rate mortgage at 4.5% or so, rather than pay slightly less interest initially on a ARM. I was able to pay ahead on the mortgage and build up some equity. I would have been in Real Deep Shit if my interest rate had reset this summer.

Actually, I guess this summer I would have gotten caught up with the bailout. The real deep shit would have been last summer.

Whichever. Don't get an ARM. If interest rates went down enough to make a big difference, you could afford to refinance with a better fixed-rate and a smaller principal.
posted by fantabulous timewaster at 8:42 PM on November 20, 2008

If the value of the townhouse goes down after you buy it...a likely scenario in the very unsettled financial situation we have today, you'll be in better shape if you have a fixed rate mortgage than an adjustable ARM. An unsettled financial market means just that...adjustable rates can go up as well as down...if the ARM goes up and your home value goes down, you have less equity, less likelihood of being able to sell it if the situation requires it, for what you have in it...or continue to manage the payments until the markets settle and home values stabilize. Just a scenario that haunts me...as I look to buy in this economy in a very unstable housing market. Fixed rate=more stability.
posted by mumstheword at 9:32 PM on November 20, 2008

Predicting interest rates is little different from, and indeed tied to predicting equity, fixed-income or commodities markets. No-one can say with certainty that rates have bottomed out and will be higher...say...5 years from now. The US could easily fall into a decade of stagflation just like Japan of the 90s, with nominal interest rates close to 0% and real rates in the negative.

Luckily, as fantabulous said, it's a moot discussion because why get an ARM when you can just refinance a fixed mortgage if rates actually fall?
posted by randomstriker at 11:23 PM on November 20, 2008

nthing the call to find a new broker. remember, your broker is not your friend. they try to stick you with all kinds of extra fees (e.g., too much title insurance). something is seriously wrong if the fees keep on changing every day and the broker is not up front about them.
posted by footnote at 7:20 AM on November 21, 2008

cnc's response is great. The key thing is that the difference in the rates just isn't that much. I'd take the 30 year fixed myself.

However, there's one reason to consider the 5/1 ARM: if you don't plan on keeping the house or the mortgage. If it's likely you'll sell the place in 5 years or if you think for some reason you're going to refinance, then the extra money you pay for the 30 year fixed is wasted. If the difference were hundreds of dollars a month that might matter. $60/month is an awfully small difference though.
posted by Nelson at 7:47 AM on November 21, 2008

My mortgage broker was hard-selling ARMs five years ago, when I was buying. I did the math: an additional $12000 across five years bought me a guaranteed rate fixed at as low as it's been in decades. Saving myself that $12000 meant exposing myself to the risk of skyrocketing rates. It sounded like a pretty good deal to me, so I got the FRM.

I am very, very glad I did that -- it's probably the single best financial decision I've ever made.
posted by Zed_Lopez at 10:06 AM on November 21, 2008

Fixed rate. No question.
posted by ikkyu2 at 10:00 PM on November 21, 2008

Fixed rate, no question. Fed rates are at 0.5%, they really can't go lower. There *may* be some lower mortgage rates in the next five years if the market felt that a lot of risk in property had disappeared - do you see that happening any time soon? I don't.
The potential upside is $15 a week, the potential downside, if rates went to 1980s levels? Hundereds of dollars a month. Just take the fixed.
posted by bystander at 12:21 AM on November 24, 2008