Adjustable Rate Mortgage- Hedge bet

May 6, 2005 1:06 PM

Can I hedge the bet of my adjustable rate mortgage by simultaneously enrolling in a 30 year fixed loan and paying off half the balance?

We enrolled in an Option ARM mortgage about 8 months ago, and we plan on staying in our new home for a long time. So far the risk has paid off, and we stashed away the extra money. However, I'm growing skittish about what rates may be like in the future. I'd like to hedge my adjustable rate bet while taking advantage of the current low fixed rates. The web research I've done into second mortgages doesn't really describe my scenario, so I'd like some man on the street advice before I contact a broker.

posted by tfmm to work & money (6 comments total)

Dude, just get a fixed mortgage ASAP. It's likely the rates will never be this low again. Lose the ARM.
posted by knave at 1:22 PM on May 6, 2005

sounds interesting but I can't quite figure out what you're thinking of doing...could you spell it out in a little more detail?
posted by jacobsee at 1:52 PM on May 6, 2005

Maybe I'm missing something obvious here. Do you have 50% equity? If not, what are you planning on using as collateral?

Without any details, I'd say your best bet is a 15 year fixed rate mortgage. Not much harder to deal with than a 30 year fixed, but you are out in half the time. If you really want to do something to take advantage of current rates, this might be the way to go.

Even with the recent rate increase, it is still a great time to get a new mortgage.
posted by bh at 4:15 PM on May 6, 2005

Stay with a 30yr fixed. It is just about the only tax break left for regular folks anymore. Where else are you going to get a loan at these rates and then get to deduct the interest. Plow the monthly difference into investment and you will easily outperform a 15 yr fixed loan, even with the slightly higher rate on the 30.

Consensus seems to be that short term rates, and hence ARMs, are going nowhere but up over the next year or two. If this successfully forestalls inflation and the economy doesn't heat up then long term rates may stay low. That is a lot of ifs. Given how low they are right now it pays to lock them in unless you are not planning to stay in this location for very long in which case the lower ARM is better.

If I understand correctly you want to shift half of your mortgage to 30 yr fixed and leave half at ARM. No? This is not a true hedge, but rather diversification. A true hedge would be to invest in something that would payoff handsomely if interest rates went up, like interest rate futures. That is a little too sophisticated play for my blood.
posted by caddis at 5:24 AM on May 7, 2005

The problem is that both mortgage lenders will want to be the primary lien-holder, i.e. the first to be paid off in the event of a foreclosure. This is why second mortgages are more expensive than firsts: the lender is taking a greater risk.
posted by electro at 8:46 AM on May 7, 2005

You can reduce your exposure to interest rate swings by (as I understand it) having half of total mortage in an ARM and half in a fixed rate mortgage, yes. [As noted above, the term "hedge" is incorrect.] The fixed rate mortgage would be the second mortgage (the ARM folks won't agree to be anything less than the first, which they are now; you'd have to pay them off completely to get them out of that position). You'd presumably pay more (as noted above) for the fixed because it's a second mortgage, but that does depend to some extent on the money you put down (if, say, 20%, you wouldn't pay much more; if less than 5%, you'd definitely pay more than if it were the first).

So you have to ask yourself - are you going to feel better with the half-and-half? If you're really worried about interest rates sharply rising, why not switch 100%? [Is there a prepayment penalty? If so, would it kick in if you paid off half?] And maybe talk to a mortgage broker about what he/she thinks of the idea, and what sort of rate he/she thinks is available in the market for you.
posted by WestCoaster at 5:43 PM on May 7, 2005