Do ARM's really save you money?
March 3, 2008 11:27 PM Subscribe
Have you used a 7/1 or 10/1 ARM to your financial advantage?
My wife and I spoke with a lender today who presented an argument that longer-term ARM's (7/1 or 10/1 terms) were potentially a very good investment. In this case, it was a 7/1, that increased 4 points from years 8-11 and capped there. (So this is not a subprime fiasco where interest rates go up 10%+ after 1-2 years or anything like that.)
His view is that if you're disciplined, you can use that money toward home improvements to increase your equity, or invest in stocks (risky) or even CD's (not risky) and get a better rate of return on your money over those years. And the chances that we'd sell or refinance before 7 years are so high that the fear of the ARM "coming due" are pretty unlikely. (His stats claimed that 99% of all homebuyers sold or refinanced in the first 7 years.) Finally, even if it did come due, we'd have more equity so refinancing would still lower our payments.
Our view is that we certainly can be disciplined about the extra money (not a problem for us) but that interest rates are pretty low right now. They might go down, sure, and then we could refinance, but once we hit historical lows for interest rates we're going to want to be in a fixed-rate loan because the chances of refinancing 7 years later with better rates is small to zero.
But I also feel we're thinking inside the box. We're first timers so we don't fully grok the nuances of things like having more equity when you do refinance, etc.
So... has anybody here successfully employed this strategy with their home purchases? Or found it not to be as great as advertised?
My wife and I spoke with a lender today who presented an argument that longer-term ARM's (7/1 or 10/1 terms) were potentially a very good investment. In this case, it was a 7/1, that increased 4 points from years 8-11 and capped there. (So this is not a subprime fiasco where interest rates go up 10%+ after 1-2 years or anything like that.)
His view is that if you're disciplined, you can use that money toward home improvements to increase your equity, or invest in stocks (risky) or even CD's (not risky) and get a better rate of return on your money over those years. And the chances that we'd sell or refinance before 7 years are so high that the fear of the ARM "coming due" are pretty unlikely. (His stats claimed that 99% of all homebuyers sold or refinanced in the first 7 years.) Finally, even if it did come due, we'd have more equity so refinancing would still lower our payments.
Our view is that we certainly can be disciplined about the extra money (not a problem for us) but that interest rates are pretty low right now. They might go down, sure, and then we could refinance, but once we hit historical lows for interest rates we're going to want to be in a fixed-rate loan because the chances of refinancing 7 years later with better rates is small to zero.
But I also feel we're thinking inside the box. We're first timers so we don't fully grok the nuances of things like having more equity when you do refinance, etc.
So... has anybody here successfully employed this strategy with their home purchases? Or found it not to be as great as advertised?
Numbers please.
Loan amount, down payment, location, points you can pay.
FWIW I use eloan.com's "Search Rates" feature almost exclusively now to track the market. I don't know how reliable this source is but it certainly appears legit.
Also, there can be no net inflation[1] without wage inflation, and I just have a hard time seeing wages rise like they did in the 1970s, and without wage inflation there won't be the wage-price spiral that also drags up interest rates.
IOW, I'm willing to be that Japan is the model we're facing for the remainder of this decade and a chunk of the next.
Anyhoo, looking at eloan (rate, points, mortage payment on a $285K loan w/ $15K down):
7/23:
6.000% 0.938% $1,709
10/20:
5.875% 2.699% $1,686
30 fixed:
6.000% 0.860% $1,709
It makes no sense to go adjustable with these numbers. Maybe your numbers are different?
Not to mention that the average loan WILL get refinanced eventually. The Fed's taking this mother down to 0% in pursuing a ZIRP, the same playbook that the Bank of Japan used in the 90s. The only way to save the housing market's recent gains from complete collapse back down to 2002 levels is jacking interest rates down to 3-4%.
[1] COLA components like food, energy, taxes, etc. may rise, but IMV the more these rise the cheaper rents -- and land prices -- will be driven down (in the absence of wage gains).
posted by panamax at 12:48 AM on March 4, 2008
Loan amount, down payment, location, points you can pay.
FWIW I use eloan.com's "Search Rates" feature almost exclusively now to track the market. I don't know how reliable this source is but it certainly appears legit.
Also, there can be no net inflation[1] without wage inflation, and I just have a hard time seeing wages rise like they did in the 1970s, and without wage inflation there won't be the wage-price spiral that also drags up interest rates.
IOW, I'm willing to be that Japan is the model we're facing for the remainder of this decade and a chunk of the next.
Anyhoo, looking at eloan (rate, points, mortage payment on a $285K loan w/ $15K down):
7/23:
6.000% 0.938% $1,709
10/20:
5.875% 2.699% $1,686
30 fixed:
6.000% 0.860% $1,709
It makes no sense to go adjustable with these numbers. Maybe your numbers are different?
Not to mention that the average loan WILL get refinanced eventually. The Fed's taking this mother down to 0% in pursuing a ZIRP, the same playbook that the Bank of Japan used in the 90s. The only way to save the housing market's recent gains from complete collapse back down to 2002 levels is jacking interest rates down to 3-4%.
[1] COLA components like food, energy, taxes, etc. may rise, but IMV the more these rise the cheaper rents -- and land prices -- will be driven down (in the absence of wage gains).
posted by panamax at 12:48 AM on March 4, 2008
Understand, too, that lenders are well-schooled at highlighting the single, narrow scenario where the plan they're pushing at you "potentially makes a good investment." Lot's of highly-speculative "ifs" abound.
And that "99% of all homebuyers sold or refinanced in the first 7 years" stat? I can't help but feel that's utter bullshit.
posted by Thorzdad at 4:29 AM on March 4, 2008
And that "99% of all homebuyers sold or refinanced in the first 7 years" stat? I can't help but feel that's utter bullshit.
posted by Thorzdad at 4:29 AM on March 4, 2008
Of course there are advantages to this. we used a 5/1 ARM 4 years ago to increase our cash flow on a property that was soon to be rented out. We'll refinantce now. We have great credit, and signed a loan that has reasonable adjust rates. The ARMS people are get eaten by now sound like they are just sucker loans...ridiculous adjustment rates to the point where the loan officer probably is sitting there praying that you won't read the stack of papers he tosses in front of you.
Also helps to put some cash down- 20% and buy a property now at low prices instead of buying high and then seeing your equity blow away with the wind in the next market correction. I would hope that 7 - 10 years would be enough of a time to ride though the next correction.
But I have a crystal ball and I'm sitting on the beach in Costa Rica right now, so I won't tell you what really happens next.
posted by johngalt at 5:37 AM on March 4, 2008
Also helps to put some cash down- 20% and buy a property now at low prices instead of buying high and then seeing your equity blow away with the wind in the next market correction. I would hope that 7 - 10 years would be enough of a time to ride though the next correction.
But I have a crystal ball and I'm sitting on the beach in Costa Rica right now, so I won't tell you what really happens next.
posted by johngalt at 5:37 AM on March 4, 2008
I did basically that when I bought my current house in 1997; I was moving to a much larger place that I would need to furnish and do some other things to, and getting a much larger loan, so I wanted to have the cash flow that an ARM would give me. I don't remember the terms, but they were pretty conservative, and I ran the numbers for a worst case scenario and knew I could still make the payments even if it went up the maximum amount. As you may remember, interest rates continued to fall after that so I have refinanced twice since then and ended up with a 15 year fixed at 4.75% that actually has a lower payment than my original loan. I knew I was taking a risk that rates would go up, but I could live with it. One caveat that I have not seen mentioned yet is to make sure there are no early payment fees on your loan if you plan to refinance in a few years; also, I paid extra on my principal each month (and did not use an expensive service to do it, just a letter to my lender stating that excess payments were to go to the principal) so that I had less to refinance each time.
Although it worked out for me, your situation may be different, so do your research and run some numbers before you commit. There are a lot of variations on the ARM theme out there, so you probably want to do some comparison shopping.
posted by TedW at 6:15 AM on March 4, 2008
Although it worked out for me, your situation may be different, so do your research and run some numbers before you commit. There are a lot of variations on the ARM theme out there, so you probably want to do some comparison shopping.
posted by TedW at 6:15 AM on March 4, 2008
we'd sell or refinance before 7 years are so high that the fear of the ARM "coming due" are pretty unlikely.
The potential problem there is that if the market's still bad when that time comes, you might not be able to sell, or perhaps not for as much as you need to pay off your mortgage. And if you don't have enough equity in your house by then, you may not be allowed to refinance. That's the problem so many homeowners are having right now. Hopefully it will improve by the time you need it to, but there's no guarantee, and that's your risk. If you can live with that risk, you might want to go ahead with this. It's not a definite "STAY AWAY!" situation, because the worst that will happen to you is your rate goes up a point a year for 4 years - not the end of the world. Just learn and understand the risks -- something else a lot of homeowners who now find themselves in trouble didn't do.
Oh but if you're interested in what we would do, I would not take that deal. I like the security of our fixed-rate mortgage. Just my preference.
posted by boomchicka at 8:33 AM on March 4, 2008
The potential problem there is that if the market's still bad when that time comes, you might not be able to sell, or perhaps not for as much as you need to pay off your mortgage. And if you don't have enough equity in your house by then, you may not be allowed to refinance. That's the problem so many homeowners are having right now. Hopefully it will improve by the time you need it to, but there's no guarantee, and that's your risk. If you can live with that risk, you might want to go ahead with this. It's not a definite "STAY AWAY!" situation, because the worst that will happen to you is your rate goes up a point a year for 4 years - not the end of the world. Just learn and understand the risks -- something else a lot of homeowners who now find themselves in trouble didn't do.
Oh but if you're interested in what we would do, I would not take that deal. I like the security of our fixed-rate mortgage. Just my preference.
posted by boomchicka at 8:33 AM on March 4, 2008
Response by poster: We're looking at putting 20% down right off the top, so we get an immediate equity position. Rates yesterday were quoted at 6.25% 30 year fixed, 5.375% 7/1 ARM.
The interesting thing, if I understood it right, is that after 7 years we'd have gained more equity with an ARM than with a fixed rate mortgage. Of course that goes out the window if we choose to get a HELOC for making home improvements... but then the improvements could add value to the home, meaning we get equity back... so much to understand.
Another interesting feature being pitched, and this is regardless of whether we go fixed or ARM, is the ability to refinance for free once a month for the life of the loan.
Paying down the principal is an option, but again wouldn't that money be better spent on a CD with its higher interest rates? Esp. knowing that the interest we pay on the mortgage is tax-deductable?
posted by rouftop at 10:22 AM on March 4, 2008
The interesting thing, if I understood it right, is that after 7 years we'd have gained more equity with an ARM than with a fixed rate mortgage. Of course that goes out the window if we choose to get a HELOC for making home improvements... but then the improvements could add value to the home, meaning we get equity back... so much to understand.
Another interesting feature being pitched, and this is regardless of whether we go fixed or ARM, is the ability to refinance for free once a month for the life of the loan.
Paying down the principal is an option, but again wouldn't that money be better spent on a CD with its higher interest rates? Esp. knowing that the interest we pay on the mortgage is tax-deductable?
posted by rouftop at 10:22 AM on March 4, 2008
I'm in the "Not as great as advertised" camp.
I took out a 7/1 ARM four and a half year ago when buying my current house, and I've been regretting it ever since. Yes, theoretically, a person could save two or three thousand dollars versus getting a slightly higher rate with a 30 year conventional. As previous posters have said, you never know what the market/rates will look like in the future; why risk it. And, yes, my mortgage person gave me the standard line about XX percent of people moving or refinancing before the seven years as up. That's just them doing a hard sell (and I'm pissed I fell for it).
My mortgage will adjust in 2010, and the mental anguish of not knowing what the rates will be at that time is not worth the money. I really wish I had gone with the 30 year conventional.
posted by disguise at 10:35 AM on March 4, 2008
I took out a 7/1 ARM four and a half year ago when buying my current house, and I've been regretting it ever since. Yes, theoretically, a person could save two or three thousand dollars versus getting a slightly higher rate with a 30 year conventional. As previous posters have said, you never know what the market/rates will look like in the future; why risk it. And, yes, my mortgage person gave me the standard line about XX percent of people moving or refinancing before the seven years as up. That's just them doing a hard sell (and I'm pissed I fell for it).
My mortgage will adjust in 2010, and the mental anguish of not knowing what the rates will be at that time is not worth the money. I really wish I had gone with the 30 year conventional.
posted by disguise at 10:35 AM on March 4, 2008
Paying down the principal is an option, but again wouldn't that money be better spent on a CD with its higher interest rates?
Good luck in finding one of those! CD interest is taxable, at your marginal rate (which for many people here in Cali is ~40%) too!
Esp. knowing that the interest we pay on the mortgage is tax-deductable?
getting rid of debt, and the interest it is creating, ASAP is highly advisable. Start with the highest APR debt and go from there.
My mom is paying off her house this year but she would have had it paid off years ago if eg. she had done the "13 payments in 12 months" trick.
Every dollar you pay now is ~4c of future payments that will be going toward principal instead of interest, every year for the next 20-odd years.
Only if you expect to be making a lot more (& easier) money in the future, or don't have a 6-month emergency fund yet, should you not throw every penny you have into pre-paying your mortgage now.
posted by panamax at 12:40 PM on March 4, 2008
Good luck in finding one of those! CD interest is taxable, at your marginal rate (which for many people here in Cali is ~40%) too!
Esp. knowing that the interest we pay on the mortgage is tax-deductable?
getting rid of debt, and the interest it is creating, ASAP is highly advisable. Start with the highest APR debt and go from there.
My mom is paying off her house this year but she would have had it paid off years ago if eg. she had done the "13 payments in 12 months" trick.
Every dollar you pay now is ~4c of future payments that will be going toward principal instead of interest, every year for the next 20-odd years.
Only if you expect to be making a lot more (& easier) money in the future, or don't have a 6-month emergency fund yet, should you not throw every penny you have into pre-paying your mortgage now.
posted by panamax at 12:40 PM on March 4, 2008
Another interesting feature being pitched, and this is regardless of whether we go fixed or ARM, is the ability to refinance for free once a month for the life of the loan.
That sounds kind of gimmicky to me; that "feature" is pretty worthless (as mentioned above, I have refinanced 2 times in 11 years and have not necessarily stayed with the same lender) and certainly costs someone money somewhere. This makes the idea of shopping around with other lenders sound even better.
posted by TedW at 1:04 PM on March 4, 2008
That sounds kind of gimmicky to me; that "feature" is pretty worthless (as mentioned above, I have refinanced 2 times in 11 years and have not necessarily stayed with the same lender) and certainly costs someone money somewhere. This makes the idea of shopping around with other lenders sound even better.
posted by TedW at 1:04 PM on March 4, 2008
wouldn't that money be better spent on a CD with its higher interest rates?
A CD that pays a higher rate than your mortgage charges? If you can find one, go nuts. But have you checked the rates for either lately? CDs are in the 3% range while mortgages are 5.5%ish and up. You would be better off making a larger down payment than investing that money in a CD.
I'm all for using your money as wisely as possible, but it sounds like you're trying to game the system a little, and that very rarely works. I'm sure your mortgage guy has a very good reason for pitching you these loans, but I'm fairly certain that "your best interest" is not that reason. For your own sanity, I still recommend a fixed-rate loan.
Esp. knowing that the interest we pay on the mortgage is tax-deductable?
I will never understand why people want to pay more interest so they can deduct it from their taxes. You only get back a small percentage of that interest, so the less interest you pay overall, the better.
posted by boomchicka at 2:21 PM on March 4, 2008
A CD that pays a higher rate than your mortgage charges? If you can find one, go nuts. But have you checked the rates for either lately? CDs are in the 3% range while mortgages are 5.5%ish and up. You would be better off making a larger down payment than investing that money in a CD.
I'm all for using your money as wisely as possible, but it sounds like you're trying to game the system a little, and that very rarely works. I'm sure your mortgage guy has a very good reason for pitching you these loans, but I'm fairly certain that "your best interest" is not that reason. For your own sanity, I still recommend a fixed-rate loan.
Esp. knowing that the interest we pay on the mortgage is tax-deductable?
I will never understand why people want to pay more interest so they can deduct it from their taxes. You only get back a small percentage of that interest, so the less interest you pay overall, the better.
posted by boomchicka at 2:21 PM on March 4, 2008
Also it sounds like you don't completely understand what it is the mortgage guy is trying to sell you. IMO that is reason enough not to take it. You should fully understand your mortgage before agreeing to anything.
posted by boomchicka at 2:23 PM on March 4, 2008
posted by boomchicka at 2:23 PM on March 4, 2008
Response by poster: I figured out from more research that he was talking about a so-called "Hybrid ARM". Here are a few articles about it.
Pro:
http://activerain.com/blogsview/150647/Adjustable-Rate-Mortgage-Risky
http://www.bankrate.com/brm/news/bank/20030908a1.asp
Con:
http://www.bankrate.com/brm/news/DrDon/20070315_ARM_fixed_hybrid_a1.asp
Sounds like it's all about risk tolerance. If you think interest rates will just go up, then it's better to stay fixed. If you think it will fluctuate, it might be better to go with an ARM and refinance. But if you do go with an ARM, you had better sock away the savings you get just in case interest rates do start to rise out of control and you can't refinance. And if we know we're going to sell in a few years, then the ARM wins.
We hope to find a place we can stay in and raise a family, but considering the housing market where I am it's possible we'll have to settle for a "starter home." If that happens I think the ARM route is appropriate. If not we have more soul searching to do.
Thanks for all the advice.
posted by rouftop at 1:35 PM on March 5, 2008
Pro:
http://activerain.com/blogsview/150647/Adjustable-Rate-Mortgage-Risky
http://www.bankrate.com/brm/news/bank/20030908a1.asp
Con:
http://www.bankrate.com/brm/news/DrDon/20070315_ARM_fixed_hybrid_a1.asp
Sounds like it's all about risk tolerance. If you think interest rates will just go up, then it's better to stay fixed. If you think it will fluctuate, it might be better to go with an ARM and refinance. But if you do go with an ARM, you had better sock away the savings you get just in case interest rates do start to rise out of control and you can't refinance. And if we know we're going to sell in a few years, then the ARM wins.
We hope to find a place we can stay in and raise a family, but considering the housing market where I am it's possible we'll have to settle for a "starter home." If that happens I think the ARM route is appropriate. If not we have more soul searching to do.
Thanks for all the advice.
posted by rouftop at 1:35 PM on March 5, 2008
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posted by caddis at 11:37 PM on March 3, 2008