7 year ARM

[Magclaw]

I currently have a 30 year fixed of 5.25% (24 years left) on $160,000. I will be refinancing tomorrow so any comments are welcome since I still have time to back out.
The new loan will be 7ARM of 3.75%. I actually bought back points on this loan so that I would have no closing fees (in the end I think I will pay 78 dollars).
Alot of people have said I was crazy first to get a worse rate just to reduce closing costs but I disagree.
In the end I will save 1.5% of 160,000 = 2,400 per year, or 16,800 over 7 years.

The important point is that the closing is really not costing me anything (78 dollar) and will immediately start saving me 200/month of interest. I am 98% positive I will be moving in the next 7 years which is why I think the ARM was acceptable.

Any feedback is appreciated

[Bob W]

Pretty good strategy.   I would have went for a lower interest, fixed, interest only loan up to 80% of equity.  Sometimes they won't do interest only with cash out options. 

You realize that in most cases points are negotiable?  Like, "hey, dude let's cut that in half"

Don't be afraid to walk away if you feel like it.   

Personally, I would never pay off a home loan at these low rates.   And you're right,  you and 95% of the readers here will be moving in less than 7 years.

The real question is why are you owning when you could be renting a comparable home with very little risk and no maintenance?

In most areas this is the best alternative.  (I even researched MMMs town and it is very much cheaper to rent a nicer home there).

If you decide to sell,  any equity immediately becomes investible.   I'm assuming you have at least 20% equity?   So around 30-40K.   

40K would generate around 4K a year over the next 7 years that would go a long way to covering your $1,200 per month rent.   No taxes,  no insurance either.

The other advantage to renting,  since you seem mobile,  is that you can leave at anytime.  Get a great job offer to start in a distant city next week,  boom you're there!

Most people don't get the risk of owning.  (actually you don't own the home,  you own the mortgage contract which is a long term rental agreement with the bank).  Ultimately the Government owns the home, since if you don't pay the taxes,  they will take it back. 

Good Luck my friend!

[MrFrugalChicago]

Pretty good strategy.   I would have went for a lower interest, fixed, interest only loan up to 80% of equity.  Sometimes they won't do interest only with cash out options. 

Depends on risk profile of OP. If they plan to live in this home until they die, and they don't feel comfortable with ALL of their assets invested - paying off your own home is a good plan. And if 7 years is the OPs payoff schedule, this is pretty perfect.

You realize that in most cases points are negotiable?  Like, "hey, dude let's cut that in half"

Don't be afraid to walk away if you feel like it.   

Personally, I would never pay off a home loan at these low rates.   And you're right,  you and 95% of the readers here will be moving in less than 7 years.

Again, depends on more facts about the OP.

The real question is why are you owning when you could be renting a comparable home with very little risk and no maintenance?

In most areas this is the best alternative.  (I even researched MMMs town and it is very much cheaper to rent a nicer home there).

I can answer this question.. many reasons...

1) I want a home to my exact standards. You cannot just add a bathroom or redo the floors in a rental.

2) I want to move when I want to move. I don't want kicked out in 2 years when my lease moves.

3) In the area I am in the process of moving to (not Chicago), nice houses never hit rental. I can live in crap, or lower middle class... but I work from home and spend about 22h a day in my home. I want a nice home. Buying is my only option.

If you decide to sell,  any equity immediately becomes investible.   I'm assuming you have at least 20% equity?   So around 30-40K.   

40K would generate around 4K a year over the next 7 years that would go a long way to covering your $1,200 per month rent.   No taxes,  no insurance either.

The other advantage to renting,  since you seem mobile,  is that you can leave at anytime.  Get a great job offer to start in a distant city next week,  boom you're there!

Some people may have strong family ties and not want to move. So being free to move is NOT an asset to everyone.

Most people don't get the risk of owning.  (actually you don't own the home,  you own the mortgage contract which is a long term rental agreement with the bank).  Ultimately the Government owns the home, since if you don't pay the taxes,  they will take it back. 

Good Luck my friend!

That is dumb. That is like saying the government owns your car, because if you use it to haul drugs and get caught - BAM - the government owns it.

OP may own his home outright in a few years. That may be a good play for him. It may not. I don't think you know enough to decide that.

[Bob W]

Pretty good strategy.   I would have went for a lower interest, fixed, interest only loan up to 80% of equity.  Sometimes they won't do interest only with cash out options. 

Depends on risk profile of OP. If they plan to live in this home until they die, and they don't feel comfortable with ALL of their assets invested - paying off your own home is a good plan. And if 7 years is the OPs payoff schedule, this is pretty perfect.

He asked for feedback.  I gave it.   

Your reasons for buying a home are valid.  From what he mentioned he has no intent of staying there long term and he didn't suggest he was looking to pay it off.

Other than the psychological reasons there isn't much financial sense in paying down a mortgage.   The last two house I lived in were foreclosures.   It happens a lot.  I rented one and bought my current one. 

My thinking is have the money to buy a home outright and then don't.  Finance it at 3.5% and invest your cash at 9%.  I bought my house for cash and then ran to the bank and financed it.  So I have a house and I have the cash both. 

Another way to look at is that when you rent a hotel room you pay as you use it.   Very few people would suggest paying an upfront fee to have hotel usage the rest of your life.

I super understand the  home vs. house thing.   I buy houses,  not homes.   My wife on the other hand bought a home.   It is a fine point but very important.  I have very little psychological attachment to houses as I was a home builder for several years and couldn't wait to get rid of them. 

Honestly,  most of the men I know would be happy living in a shed as long as it had a fridge and TV.  (see the post on living in a shed)

You realize that in most cases points are negotiable?  Like, "hey, dude let's cut that in half"

Don't be afraid to walk away if you feel like it.   

Personally, I would never pay off a home loan at these low rates.   And you're right,  you and 95% of the readers here will be moving in less than 7 years.

Again, depends on more facts about the OP.

The real question is why are you owning when you could be renting a comparable home with very little risk and no maintenance?

In most areas this is the best alternative.  (I even researched MMMs town and it is very much cheaper to rent a nicer home there).

I can answer this question.. many reasons...

1) I want a home to my exact standards. You cannot just add a bathroom or redo the floors in a rental.

2) I want to move when I want to move. I don't want kicked out in 2 years when my lease moves.

3) In the area I am in the process of moving to (not Chicago), nice houses never hit rental. I can live in crap, or lower middle class... but I work from home and spend about 22h a day in my home. I want a nice home. Buying is my only option.

If you decide to sell,  any equity immediately becomes investible.   I'm assuming you have at least 20% equity?   So around 30-40K.   

40K would generate around 4K a year over the next 7 years that would go a long way to covering your $1,200 per month rent.   No taxes,  no insurance either.

The other advantage to renting,  since you seem mobile,  is that you can leave at anytime.  Get a great job offer to start in a distant city next week,  boom you're there!

Some people may have strong family ties and not want to move. So being free to move is NOT an asset to everyone.

Most people don't get the risk of owning.  (actually you don't own the home,  you own the mortgage contract which is a long term rental agreement with the bank).  Ultimately the Government owns the home, since if you don't pay the taxes,  they will take it back. 

Good Luck my friend!

That is dumb. That is like saying the government owns your car, because if you use it to haul drugs and get caught - BAM - the government owns it.

OP may own his home outright in a few years. That may be a good play for him. It may not. I don't think you know enough to decide that.

He asked for feed back and I gave it.   

I've been in real estate and have built and sold dozens of "homes."  They are "houses" to me. 

I bought my current foreclosure house for cash and ran to the mortgage office and financed it at 3% while taking an additional 25K out in cash.   

To each his own but if you run the numbers paying off a home with interest rates this low will not pencil out.   Even Wal-Mart,  Walgreens and most McDonalds lease their lots.  The do this because they get a good rate and they can put their cash to use to generate income and build their businesses.  They are pretty smart people so I think I'll follow their lead and put my cash to use building it rather than tying it up in a house. 

Paying off houses vs mortgaging them has been discussed many times on this forum.  So we all will need to agree to disagree on this one.   

[MrFrugalChicago]

He asked for feed back and I gave it.   

I've been in real estate and have built and sold dozens of "homes."  They are "houses" to me. 

That is good, never get too invested in a THING.

I bought my current foreclosure house for cash and ran to the mortgage office and financed it at 3% while taking an additional 25K out in cash.   

Hum, by me you would need to hold a house for 12 months after a cash purchase before you can get financing in it.

To each his own but if you run the numbers paying off a home with interest rates this low will not pencil out.   Even Wal-Mart,  Walgreens and most McDonalds lease their lots.  The do this because they get a good rate and they can put their cash to use to generate income and build their businesses.  They are pretty smart people so I think I'll follow their lead and put my cash to use building it rather than tying it up in a house. 

Paying off houses vs mortgaging them has been discussed many times on this forum.  So we all will need to agree to disagree on this one.   

Corporate tax rate and personal tax rate are very very different. It is kind of silly to use that as evidence one way or another. Plus I could provide counter evidence like - Sears owns all their own land. They should have been out of business 20 years ago for being irrelevant.. but they are still around BECAUSE they own the land. So it didn't work out too bad for them staying alive.


Also I would like info on this mythical 9% no risk investment you will do (hint, no such thing). The OP has a "guaranteed" 3.5%+ investment in paying off his mortgage. 

[Numbers Man]

The 7 year ARM is a good solution it you are sure you will be out of the house within 7 years. It sure beats paying over 5%.

[MrFrugalChicago]

The 7 year ARM is a good solution it you are sure you will be out of the house within 7 years. It sure beats paying over 5%.

Well doesn't have to be out in 7 years. Generally the WORST case breakeven, i.e. the cost of the 7 year ARM with the max raise after 7 years every year vs a 30 year fixed, ends up at somewhere n the 9-10 year range. So if somewhere around year 9 or so he either
a) Paid off
b) Refied into fixed
c) Sold the place

He would be better off with the ARM.

The exact breakeven point varies for sure.  And it should be compared against the current price of a 30 year fixed, which is in the 4-4.25% range

[Numbers Man]

The 7 year ARM is a good solution it you are sure you will be out of the house within 7 years. It sure beats paying over 5%.

Well doesn't have to be out in 7 years. Generally the WORST case breakeven, i.e. the cost of the 7 year ARM with the max raise after 7 years every year vs a 30 year fixed, ends up at somewhere n the 9-10 year range. So if somewhere around year 9 or so he either
a) Paid off
b) Refied into fixed
c) Sold the place

He would be better off with the ARM.

The exact breakeven point varies for sure.  And it should be compared against the current price of a 30 year fixed, which is in the 4-4.25% range

That made me dizzy reading that, the OP said he wanted to be out of the house in 7 years.

[MrFrugalChicago]

That made me dizzy reading that, the OP said he wanted to be out of the house in 7 years.

Then you aren't a good numbers man.

If he wants to stay LESS than 7 years, very likely he would be better served with a 5 year ARM.

[Numbers Man]

That made me dizzy reading that, the OP said he wanted to be out of the house in 7 years.

Then you aren't a good numbers man.

If he wants to stay LESS than 7 years, very likely he would be better served with a 5 year ARM.

He wants to stay 7 years, not 5. And there is no rate given for a 5 year ARM. You're definitely misreading the OP's question.

[MrFrugalChicago]

He wants to stay 7 years, not 5. And there is no rate given for a 5 year ARM. You're definitely misreading the OP's question.

As the numbers man, you are pretty bad with numbers.

A 5 year ARM will be lower interest rate than a 7 year ARM . Even at the 7 year mark, a 5 year ARM is often a better value.

Can you please ask for a name change?

[Numbers Man]

He wants to stay 7 years, not 5. And there is no rate given for a 5 year ARM. You're definitely misreading the OP's question.

As the numbers man, you are pretty bad with numbers.

A 5 year ARM will be lower interest rate than a 7 year ARM . Even at the 7 year mark, a 5 year ARM is often a better value.

Can you please ask for a name change?

MrFrugalChicago - You're not looking at the term of the loan versus the length of time that he wants to stay in the property. A five year arm can adjust upwards in interest rate after the five year term. I'm sorry that you can't accept that. Again read what the OP was asking.

[MrFrugalChicago]

MrFrugalChicago - You're not looking at the term of the loan versus the length of time that he wants to stay in the property. A five year arm can adjust upwards in interest rate after the five year term. I'm sorry that you can't accept that. Again read what the OP was asking.

And you are not understanding what a break even point is.

Say the term of the 7/2/5 year ARM is fixed at 5%.
Say the term of the 5/2/5  ARM is fixed at 4% for the first 5 years.

Year 6 the max the 5 year  ARM could cost is 6% (see the little 2 in 5/2/5? That is max raise per year after the 5 years), putting him 1% over the 7 year arm (but over the entire loan, he is STILL ahead, as his average loan interest rate has been 4.33%).
year 7 the max the 5 year ARM could cost is 8%, putting his average loan cost at 4.85% over the 7 years.

Meaning - Over 7 years, the 5 year ARM with the MAXIMUM POSSIBLE INTEREST RATE RAISE (not likely) still COULD beat the 7 year ARM.

Need to look at the actual terms, and do the "numbers" to know for sure.

Please understand how mortgages work before giving advice.

[athenap]

When we bought our home in 2003, we thought we will be moving for sure within 7 years. Hence, 7 year ARM of 4.75%, while 30 year fixed at the time hovered around 6%. Since then, we refinanced twice, both times into 7 year ARMs - 3.5% in 2009 (fixed rate was just under 5%) and 2.25% in 2013 (fixed rate at the lowest was around 3.5%, I think), all with no points or closing costs. So far, the ARM strategy has been paying off, even without moving.

Similarly, for one of the rental properties bought in 2004 with 5 year ARM, the fixed part of rate was 4.25% and then when it started resetting, it kept in falling down, to 3.25% currently, 10 years later.

I am aware that with refinancing, we have reset the mortgage countdown twice - the way I decided to combat that issue is by saving a difference between original mortgage payment and the current mortgage payment and eventually paying off the whole thing in one fell swoop on the original schedule if the rates rise too high and we can't refi for some reason.  And I ran the numbers with margins, caps, etc, to see how long before 30 year will pay break even with 7 year ARM in each case, and in each case it was sufficiently long time to take the risk. It may have been even more financially advantageous to get 5 year ARM in some cases, but we were more comfortable with 7 year terms, mostly from emotional perspective, not actual hard numbers.