Home mortgages: fixed rate vs. ARM

[WiseOne]

I've (finally!) managed to snag myself a nice apartment with all the criteria.  Mainly, 1) walking distance to work in a nice neighborhood, 2) workable kitchen with window, and 3) not cave-like.  Also it passed the architect review (i.e. my brother).

The process I went through could probably make someone a really nice blog entry.  It's a total zoo out there.  I was negotiating for this place, then someone swooped in with an all cash offer, then a few days later it fell through.  My broker told me that almost a third of Manhattan purchases are now cash deals, and most of the rest are non-contingent on financing.  Her feeling is that the upcoming (maybe not so upcoming now :-) interest rate increases aren't actually the reason for this, and that it has to do with population & housing stock fundamentals in the < $2 million ("low end") market.

Can I draw on the wisdom of the forum as regards mortgage type?  I ran some numbers, and it looks like a 7/1 ARM is actually a very consistent win over a 30 year fixed mortgage at current rates and assuming even worst case scenarios for interest rate increases, as long you use the initial payment difference to either pay the mortgage down faster or invest.  The specific numbers I looked at:  30 year fixed, 3.75%.  7/1 ARM, 3.125% with up to 2% yearly increases capped at 5%. 

Of note, I read somewhere that Harry Browne recommended ARM over fixed rate mortgages, as long as you balance it with a small gold holding on the side to handle interest rate increases.  I don't recall that he provided specific recommendations on how much gold to keep.  It's certainly an interesting idea.  With the PP being somewhat overweight in gold, I'd probably just stay with the 25% bands and not worry about keeping an extra stake.

In my case I suspect the 7/1 ARM is a no brainer, as I am going to be financing only about a third of the purchase price and plan on knocking the thing off in 7-10 years max.  (As some of you know I really dislike debt.)  But, just wondering what people's thoughts are since that's a rather unconventional choice unless you plan to move - which I don't.  This place is definitely a keeper.

[moda0306]

I've (finally!) managed to snag myself a nice apartment with all the criteria.  Mainly, 1) walking distance to work in a nice neighborhood, 2) workable kitchen with window, and 3) not cave-like.  Also it passed the architect review (i.e. my brother).

The process I went through could probably make someone a really nice blog entry.  It's a total zoo out there.  I was negotiating for this place, then someone swooped in with an all cash offer, then a few days later it fell through.  My broker told me that almost a third of Manhattan purchases are now cash deals, and most of the rest are non-contingent on financing.  Her feeling is that the upcoming (maybe not so upcoming now :-) interest rate increases aren't actually the reason for this, and that it has to do with population & housing stock fundamentals in the < $2 million ("low end") market.

Can I draw on the wisdom of the forum as regards mortgage type?  I ran some numbers, and it looks like a 7/1 ARM is actually a very consistent win over a 30 year fixed mortgage at current rates and assuming even worst case scenarios for interest rate increases, as long you use the initial payment difference to either pay the mortgage down faster or invest.  The specific numbers I looked at:  30 year fixed, 3.75%.  7/1 ARM, 3.125% with up to 2% yearly increases capped at 5%. 

Of note, I read somewhere that Harry Browne recommended ARM over fixed rate mortgages, as long as you balance it with a small gold holding on the side to handle interest rate increases.  I don't recall that he provided specific recommendations on how much gold to keep.  It's certainly an interesting idea.  With the PP being somewhat overweight in gold, I'd probably just stay with the 25% bands and not worry about keeping an extra stake.

In my case I suspect the 7/1 ARM is a no brainer, as I am going to be financing only about a third of the purchase price and plan on knocking the thing off in 7-10 years max.  (As some of you know I really dislike debt.)  But, just wondering what people's thoughts are since that's a rather unconventional choice unless you plan to move - which I don't.  This place is definitely a keeper.

At that spread I love the 7/1 ARM.  Even better than the 15, IMO (payment flexibility), but that's just me.  I have yet to talk to someone that could articulate very strong reasons to avoid ARMs other than the obvious "worst case" interest rate scenario.

But I'm a "deflationist" and think interests will stay low for some time, so do know that this colors a good chunk of my opinion on this. There are sure to be other deficit hawks here who would disagree with me.

[Libertarian666]

For less than a 1% difference, I would definitely take the fixed rate.
But as TennPaGa suggested, I would check on the 15-year rate, which should make the difference much smaller. Since you plan to pay it off before that length of time anyway, the higher payment would make very little difference.

[WiseOne]

I had a nice reply typed when the forum crashed again...

anyway, I discounted the 15 year because it's not much of an advantage over the 30 year rate (3.3%) plus I wanted to focus on saving/investing earlier on until I hit a specific goal, then go all out to get rid of the mortgage after the goal is met in about 3 years.  As moda pointed out, the 15 year locks you into the extra payments from day 1.  I took a 15 year previously when it gave me a full 1% advantage over the 30 year, but that was a bit uncomfortable.

Kind of like HB's recommendation to balance the ARM with gold - minimizes interest and the gold is a nice insurance policy against the conditions that would likely force big rate increases.

[Libertarian666]

I had a nice reply typed when the forum crashed again...

anyway, I discounted the 15 year because it's not much of an advantage over the 30 year rate (3.3%) plus I wanted to focus on saving/investing earlier on until I hit a specific goal, then go all out to get rid of the mortgage after the goal is met in about 3 years.  As moda pointed out, the 15 year locks you into the extra payments from day 1.  I took a 15 year previously when it gave me a full 1% advantage over the 30 year, but that was a bit uncomfortable.

Kind of like HB's recommendation to balance the ARM with gold - minimizes interest and the gold is a nice insurance policy against the conditions that would likely force big rate increases.

Ok, but 3.3% for 15 years means only 0.175% advantage to the ARM in the best case. And remember, the greater payments are actually equivalent to buying bonds (or selling negative bonds). Also, you don't know that gold will go up if there are interest rate increases.

It doesn't sound like a good risk-reward trade-off to me, but it's your money of course.

[MediumTex]

If you really think you are going to pay it off in 7 years, the ARM should be the obvious choice.

But I'm also thinking that if the plan is to pay it off in 7 years, a 15 year fixed rate shouldn't be a scary thing, and locking in a rate for 15 years for a few dollars more a month would give me comfort over just having it locked in for 7 years, assuming that paying it off in 7-15 years is something you are sure you are going to do.

[mathjak107]

most  homeowners in america move every 5-7 years during their family raising years  so arms would be the best choices .

[Tyler]

most  homeowners in america move every 5-7 years during their family raising years  so arms would be the best choices .

Except when prices fall and they're underwater and don't have the cash to bring to the table to sell or refinance when the rates adjust.  I had a friend in San Francisco who was financially ruined by their ARM.  Most homeowners in America have no liquid savings, so an ARM is a lot riskier than they think.

In WiseOne's situation I agree that it sounds like a reasonable option -- real savings gives you a lot more flexibility.  If you can afford to pay it off in full at the end of your 7-year term (not necessarily as the primary plan, but in case the value/rates move against you) then your downside is properly capped and you should be fine. I personally chose a 15-year fixed mortgage in a similar situation, but I can see the reasoning for the other side as well. 

[dragoncar]

most  homeowners in america move every 5-7 years during their family raising years  so arms would be the best choices .

Except when prices fall and they're underwater and don't have the cash to bring to the table to sell or refinance when the rates adjust.  I had a friend in San Francisco who was financially ruined by their ARM.  Most homeowners in America have no liquid savings, so an ARM is a lot riskier than they think.

In WiseOne's situation I agree that it sounds like a reasonable option -- real savings gives you a lot more flexibility.  If you can afford to pay it off in full at the end of your 7-year term (not necessarily as the primary plan, but in case the value/rates move against you) then your downside is properly capped and you should be fine. I personally chose a 15-year fixed mortgage in a similar situation, but I can see the reasoning for the other side as well.

If your friend had a non-recourse mortgage, an ARM shouldn't be financially ruinous even when prices fall (and in SF, they fell very little).  If your friend had done a major cash-out refinance and blew the money, then it wasn't the ARM that ruined him

[Tyler]

There certainly could have been more to the story in her case.  She was kind of a trainwreck.

That said, even with a non-recourse mortgage walking away still has financial and credit repercussions that linger for a long while.  ARMs carry certain risks that fixed mortgages do not.  Everything has a tradeoff.

[mathjak107]

most  homeowners in america move every 5-7 years during their family raising years  so arms would be the best choices .

Except when prices fall and they're underwater and don't have the cash to bring to the table to sell or refinance when the rates adjust.  I had a friend in San Francisco who was financially ruined by their ARM.  Most homeowners in America have no liquid savings, so an ARM is a lot riskier than they think.

In WiseOne's situation I agree that it sounds like a reasonable option -- real savings gives you a lot more flexibility.  If you can afford to pay it off in full at the end of your 7-year term (not necessarily as the primary plan, but in case the value/rates move against you) then your downside is properly capped and you should be fine. I personally chose a 15-year fixed mortgage in a similar situation, but I can see the reasoning for the other side as well.

there always will be exceptions .

you can even throw in when you lose your job the lower arm payments would give you more cash flow then fixed  at least during the arm period and maybe more if rates fell then even refinancing a fixed .

but even today statistics show many folks do still move in that 5-7 year time frame ..


there are always going to be situations on both sides of something .