Should I risk losing an ARM?
August 7, 2013 1:59 PM Subscribe
Should we consider an ARM in the current mortgage market?
We are buying a rather expensive house due to real estate costs in the area - so needless to say we are pushing the boundaries of affordable. We are not putting a large amount down - we would love to put down 20% - but that would not happen for a good while and we are not exactly 25.
Debating an ARM vs. fixed. We plan on being in the house probably 5-10 years. We have access to an ARM that does not require 10% down. The 10 year ARM is about $200-$300 a month cheaper than the 30 year fixed. Cap of 2% growth in interest rate a year with a 9% 10 year cap. No penalty for refinancing.
It would be really nice to be able to put that $200-$300 a month into savings. Upside is $24,00-$36,000 a year over the ten years. Obviously the downside could be a bit - assuming we refinanced to a 30 year fixed it rates were clearly going up I figure it could end up costing us $12,000-$24,000 on the downside.
Also not sure if there are any other types of ARMs than the one I described that anyone has experienced and could or would not recommend.
We are buying a rather expensive house due to real estate costs in the area - so needless to say we are pushing the boundaries of affordable. We are not putting a large amount down - we would love to put down 20% - but that would not happen for a good while and we are not exactly 25.
Debating an ARM vs. fixed. We plan on being in the house probably 5-10 years. We have access to an ARM that does not require 10% down. The 10 year ARM is about $200-$300 a month cheaper than the 30 year fixed. Cap of 2% growth in interest rate a year with a 9% 10 year cap. No penalty for refinancing.
It would be really nice to be able to put that $200-$300 a month into savings. Upside is $24,00-$36,000 a year over the ten years. Obviously the downside could be a bit - assuming we refinanced to a 30 year fixed it rates were clearly going up I figure it could end up costing us $12,000-$24,000 on the downside.
Also not sure if there are any other types of ARMs than the one I described that anyone has experienced and could or would not recommend.
Your mortgage will probably be the highest monthly cost in your budget. Do you really want that to be a variable cost? If the economy keeps improving, interest rates will eventually start to rise and so will the rate on your loan.
I don't think that I would ever take a variable rate mortgage, but then again I am very personally financially conservative.
posted by Aizkolari at 2:08 PM on August 7, 2013
I don't think that I would ever take a variable rate mortgage, but then again I am very personally financially conservative.
posted by Aizkolari at 2:08 PM on August 7, 2013
Do you know the answer to this question: How much higher will my payment be when my ARM rate changes?
posted by boo_radley at 2:08 PM on August 7, 2013
posted by boo_radley at 2:08 PM on August 7, 2013
If you're sure you're going to move before the rate on your ARM resets, then I think the ARM is a good idea. We have one on our house. Actually, we got an ARM when we originally bought the house; it was a 7/1 at 3.875%, and then three years later (a couple months ago) refi'd into a 5/1 at 2.375%. We will definitely move within the next five years.
If there is any chance that you will have the house longer than five years, there is a very good chance your house payments will go up significantly when the ARM resets. Rates are still near historical lows but on their way up. Your new rate will be higher than the initial rate, guaranteed. If you do go for the ARM, be sure to check to see how much it can go up the first year, how much it can go up each year after that, the amount it can go up in total, and the effect each rate will have on your payment. Most ARMs are based on an index (such as LIBOR) plus a margin; you want the margin to be as small as possible. Compare ARMs based on these factors as well as rate and closing costs.
Of course, if you do plan to move before the ARM resets, you will also be paying a higher rate, albeit for your next mortgage. The ARM merely puts you that situation even if you don't move. On the other hand, five years is plenty of time to pay off any debts you may have and put some money away, so you can be in a better situation for an ARM adjustment, a new home, or a re-fi.
I will note that $300 a month is not $36,000 a year, however.
posted by kindall at 2:09 PM on August 7, 2013 [2 favorites]
If there is any chance that you will have the house longer than five years, there is a very good chance your house payments will go up significantly when the ARM resets. Rates are still near historical lows but on their way up. Your new rate will be higher than the initial rate, guaranteed. If you do go for the ARM, be sure to check to see how much it can go up the first year, how much it can go up each year after that, the amount it can go up in total, and the effect each rate will have on your payment. Most ARMs are based on an index (such as LIBOR) plus a margin; you want the margin to be as small as possible. Compare ARMs based on these factors as well as rate and closing costs.
Of course, if you do plan to move before the ARM resets, you will also be paying a higher rate, albeit for your next mortgage. The ARM merely puts you that situation even if you don't move. On the other hand, five years is plenty of time to pay off any debts you may have and put some money away, so you can be in a better situation for an ARM adjustment, a new home, or a re-fi.
I will note that $300 a month is not $36,000 a year, however.
posted by kindall at 2:09 PM on August 7, 2013 [2 favorites]
What is the interest rate on the ARM? A low payment means you either pay less in interest (because the rate is lower) or you pay less against the principal, or some combination. You can look at the principal repayment as money put in savings, because it increases your equity in the home. So it's not really as simple as simply comparing the monthly payments to conclude that you are saving $200-300 per month.
posted by payoto at 2:10 PM on August 7, 2013
posted by payoto at 2:10 PM on August 7, 2013
If you are on the edge financially and getting an ARM is the only way to afford a house, I'd say give it a miss. ESPECIALLY since you don't see this as a Forever kind of deal.
Do you have a six-month emergency fund? Do you have a spare $10,000 in case you need to replace the roof?
Do you know how much you'll pay in regular maintenance and upkeep?
I always think Fixed is best, because there are no surprises (unless your insurance or taxes go up.)
I'm getting out of being a homeowner because it's too expensive compared to renting. I paid that $10,000 contingency a few times over in the 7 years we've owned our house.
I have friends who have an interest-only mortgage on their house. It seemed a good idea in 2006, now, it's not so cute.
posted by Ruthless Bunny at 2:12 PM on August 7, 2013 [1 favorite]
Do you have a six-month emergency fund? Do you have a spare $10,000 in case you need to replace the roof?
Do you know how much you'll pay in regular maintenance and upkeep?
I always think Fixed is best, because there are no surprises (unless your insurance or taxes go up.)
I'm getting out of being a homeowner because it's too expensive compared to renting. I paid that $10,000 contingency a few times over in the 7 years we've owned our house.
I have friends who have an interest-only mortgage on their house. It seemed a good idea in 2006, now, it's not so cute.
posted by Ruthless Bunny at 2:12 PM on August 7, 2013 [1 favorite]
Interest rates are crazy low (even with the recent spike), and if the value of this property sinks, you won't be able to refinance.
posted by bensherman at 2:12 PM on August 7, 2013 [2 favorites]
posted by bensherman at 2:12 PM on August 7, 2013 [2 favorites]
I am a mortgage loan officer. IANYMLO.
Nobody knows what rates will be like in 10 years but they are on the upswing now and they will almost certainly be higher than they are now. This means when the ARM adjusts, and you want to refinance, you could be in for a rude surprise.
I am asking every borrower how long they intend to stay in the property if they want an ARM, and if they have the resources to pay the loan off if rates go through the roof. If you intend to be there for the long haul, you may wish to re-think the ARM option. Just my opinion.
posted by brownrd at 2:16 PM on August 7, 2013 [2 favorites]
Nobody knows what rates will be like in 10 years but they are on the upswing now and they will almost certainly be higher than they are now. This means when the ARM adjusts, and you want to refinance, you could be in for a rude surprise.
I am asking every borrower how long they intend to stay in the property if they want an ARM, and if they have the resources to pay the loan off if rates go through the roof. If you intend to be there for the long haul, you may wish to re-think the ARM option. Just my opinion.
posted by brownrd at 2:16 PM on August 7, 2013 [2 favorites]
Your questions doesn't state what your fixed rate would be or what your ARM rate would start at. I work in mortgage servicing - default loan collections. The vast, vast majority of the defaulted loans I see on a daily basis are ARMS (or interest-onlys, but that's a whole other cluster****) where the rate skyrocketed, the house is underwater, the owner couldn't refi and can't afford thier new payment. Based off this, I would NOT, barring really specific circumstances that your OP doesn't include, get an ARM mortgage. Even if you plan to move, do you know for certain that your home will be worth it's full payoff in 10 years? Are you prepared to eat the higher payment or take the risk of defaulting if not?
Agreeing with most of the other commentors - unless you definitely have enough income to cover a much higher payment, don't do it.
posted by celtalitha at 2:18 PM on August 7, 2013
Agreeing with most of the other commentors - unless you definitely have enough income to cover a much higher payment, don't do it.
posted by celtalitha at 2:18 PM on August 7, 2013
rates will go up. I'd pass.
posted by jpe at 4:11 PM on August 7, 2013 [1 favorite]
posted by jpe at 4:11 PM on August 7, 2013 [1 favorite]
I think previous answers are missing something - are you willing to walk away from the house and loan if it goes against you? If yes, and you have no moral issues with defaulting when you could still pay, then yes you should take the ARM, or whatever type of lowest rate loan you can get, and enjoy the optionality of "heads I win tails everyone else loses" with respect to both rates and house prices. In the end thats what really matters here - house prices, rates, resets - its all incorporated into what your response will be.
posted by H. Roark at 4:13 PM on August 7, 2013
posted by H. Roark at 4:13 PM on August 7, 2013
With the low rates at the moment, there is no way I would do an ARM. The no penalty for refinancing the ARM doesn't help you much if your only refi options are at rates that are much higher than they are now. If you're positive you will move out before your rate can move, fine, but it would suck to be kicked out of your house because your rate started to move and you couldn't handle the new payments anymore.
posted by craven_morhead at 4:33 PM on August 7, 2013 [1 favorite]
posted by craven_morhead at 4:33 PM on August 7, 2013 [1 favorite]
If you think there is a high probability that you will be in the house for less than 10 years, and the 10-year ARM's payment is lower because the interest rate is lower (that is, roughly the same amount is going towards the principal in both mortgages), the ARM is unambiguously the better deal, and I would choose that option.
However, as others point out, you leave out what the respective rates and closing costs are. If the interest rate difference is small and/or offset by higher closing costs, then you need to consider the total package, not just the monthly payments.
posted by deadweightloss at 4:50 PM on August 7, 2013 [1 favorite]
However, as others point out, you leave out what the respective rates and closing costs are. If the interest rate difference is small and/or offset by higher closing costs, then you need to consider the total package, not just the monthly payments.
posted by deadweightloss at 4:50 PM on August 7, 2013 [1 favorite]
Never put yourself in a position where you have to sell at some point in the future. This is what caused the financial meltdown- people assuming housing prices would never stop going up, and making life plans based on that folly. You don't know the condition of the marketplace in 5-10 years. Your house could be worth less money. What then? Who is going to give you a mortgage for 110% of the value of a house?
The only time to use an ARM is when you already have the money to buy the house, but would rather use it for something more profitable. So if you can't refinance the ARM when the rate adjusts, you can just pay it off or afford the new payment.
Rule of thumb: you can't afford the house if you can't afford a 30 year fixed mortgage on it. Especially with rates as low as they are.
posted by gjc at 5:05 PM on August 7, 2013
The only time to use an ARM is when you already have the money to buy the house, but would rather use it for something more profitable. So if you can't refinance the ARM when the rate adjusts, you can just pay it off or afford the new payment.
Rule of thumb: you can't afford the house if you can't afford a 30 year fixed mortgage on it. Especially with rates as low as they are.
posted by gjc at 5:05 PM on August 7, 2013
You're investing in a piece of real-estate, the growth rate of which you have little control over and can't easily liquidate. Additionally, it's a leveraged investment (you're taking on debt to make the investment) which automatically magnifies the risk. On top of all that, you're thinking about adding interest rate risk.
You may intend to move before the rate adjusts but what if the value of your property dips and the value of the houses where you want to move to have increased? Or, you might be rushed to sell at a disadvantageous price. A looming interest rate adjustment might force into making poor decisions.
There are enough variables involved with owning a house that I wouldn't add your interest rate to them.
posted by VTX at 7:27 PM on August 7, 2013
You may intend to move before the rate adjusts but what if the value of your property dips and the value of the houses where you want to move to have increased? Or, you might be rushed to sell at a disadvantageous price. A looming interest rate adjustment might force into making poor decisions.
There are enough variables involved with owning a house that I wouldn't add your interest rate to them.
posted by VTX at 7:27 PM on August 7, 2013
Only do this if you could afford the payment with the rate +5% on what it is now. Rates could easily be up 5% when you come to refinance or renew
posted by dave99 at 5:32 AM on August 8, 2013
posted by dave99 at 5:32 AM on August 8, 2013
Fixed rates are enviably low right now, so I would only go with an ARM if you are pretty sure that you intend to sell in the near term. I can entirely understand how getting a fixed mortgage now and moving/selling in ~7 years would be throwing money away, but the rough housing market of the past seven years has taught us that you can get upside down in a house and be forced to hold it. Your risk with the ARM is that house value could drop and you would have to choose between a bad selling price or an increased monthly mortgage.
posted by dgran at 8:02 AM on August 8, 2013
posted by dgran at 8:02 AM on August 8, 2013
assuming we refinanced to a 30 year fixed it rates were clearly going up I figure it could end up costing us $12,000-$24,000 on the downside
The flaw in this reasoning is the part where you assume you will be able to refinance.
The 10 year ARM is about $200-$300 a month cheaper than the 30 year fixed.
That's a big difference. Is there a balloon payment due at the end of those 10 years? See above.
posted by yohko at 3:39 PM on August 8, 2013 [1 favorite]
The flaw in this reasoning is the part where you assume you will be able to refinance.
The 10 year ARM is about $200-$300 a month cheaper than the 30 year fixed.
That's a big difference. Is there a balloon payment due at the end of those 10 years? See above.
posted by yohko at 3:39 PM on August 8, 2013 [1 favorite]
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posted by IzzeYum at 2:00 PM on August 7, 2013