Author Topic: Monetary policy / ARM mortgage  (Read 2651 times)

cube.37

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Monetary policy / ARM mortgage
« on: October 21, 2016, 01:43:00 PM »
Hi all,

1.5 years ago my wife and I purchased a house. I did quite a bit of research back then on housing and the types of mortgages, but relative to today, was a total noob.

We ended up doing a 7/1 ARM at 3.25%, capped at 8.25% (minimum 2.25%). My reasoning was that we agreed we would not be staying in the house for more than 7 years (by then we will likely have children and need to move away, likely to the suburbs), while 5 years was still questionable. In addition to that, because the property is inside Boston, it would give very poor returns as a rental property. (side note - my upstairs is rented out and with the rental pricing they shared with me + the costs of using a property manager, there is no way they are getting a worthy return). There is a chance the property can appreciate rapidly because we're in a developing area, but 5.5 years down the road it will likely slow down and even then, it would be a speculative real estate investment versus a cash flowing rental (i want the latter).

With all that in mind, we decided to do the 7/1 ARM. However, I am now realizing that even if we do stick with the plan and move out near the end of year 7, there could be another housing crash right beforehand and we could just be stuck with a home with high rates.

My question is: if there is another housing market crash right before our scheduled time to sell the house, is there a reason the fed wouldn't bring down the interest rates in response to the crash? If the rates go back down in response to a housing crisis, I see no downside - yes we might not be able to sell the house, but the monthly payments wont go up either so we can just wait it out. Or is there another reason I should change to a fixed rate before rates possibly go up later this year?

That is my understanding of our current economic policy. Maybe 7 years down the road there will be a general agreement that easing monetary policy after a crash just makes things worse..

(p.s. feel free to move this to the real estate/landlording topic. i was debating whether this was specifically real estate related or more general due to questions about monetary policy)
« Last Edit: October 21, 2016, 01:50:03 PM by cube.37 »

Jack

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Re: Monetary policy / ARM mortgage
« Reply #1 on: October 21, 2016, 01:59:21 PM »
My question is: if there is another housing market crash right before our scheduled time to sell the house, is there a reason the fed wouldn't bring down the interest rates in response to the crash?

What do you mean "back" down? They haven't gone up since the last crash yet! They've been hovering in the 0-0.5% range since 2010.

Therefore, what you're really asking is "if housing crashed again, would the Fed take the rates sharply negative," which also raises the question "what would happen to the US economy if the rates went sharply negative?"

As far as I can tell, the answer to both those questions is "who knows?"

cube.37

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Re: Monetary policy / ARM mortgage
« Reply #2 on: October 21, 2016, 02:28:34 PM »
My question is: if there is another housing market crash right before our scheduled time to sell the house, is there a reason the fed wouldn't bring down the interest rates in response to the crash?

What do you mean "back" down? They haven't gone up since the last crash yet! They've been hovering in the 0-0.5% range since 2010.

Therefore, what you're really asking is "if housing crashed again, would the Fed take the rates sharply negative," which also raises the question "what would happen to the US economy if the rates went sharply negative?"

As far as I can tell, the answer to both those questions is "who knows?"


Sorry, I should've clarified. If interest rates do go back up, and then..
there is another housing market crash right before our scheduled time to sell the house, is there a reason the fed wouldn't bring down the interest rates in response to the crash?

Telecaster

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Re: Monetary policy / ARM mortgage
« Reply #3 on: October 21, 2016, 02:38:13 PM »
Too many moving parts.  You can come up with "what ifs" all day long.   No one does what the Fed will do seven years from now, so don't worry about it.   

Here's the thing, if you really are planning on moving in seven years, than a 7/1 is a good deal, and I believe that even if rates go up, you wind up breaking even at like year 10 or something.  Maybe year 12, I forget, but there is typically a max it can increase each year.  So even if the disaster you describe strikes, it won't change your situation very much for at least a few years. 

I like a nice fact 30-year in almost all circumstances for the generally reasons you bring up.  No matter what happens with the economy down the road, I'm fine.  These ARMS and especially balloons are like little time bombs you set for yourself.   You put yourself in a position where you have to re-finance no matter what your personal situation is in the future. 

Langer83

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Re: Monetary policy / ARM mortgage
« Reply #4 on: October 21, 2016, 03:08:35 PM »
The odds of there being a housing crash AND high interest rates are extremely low. The only way that would happen would be a catastrophic event that isn't really possible to prepare for.

I'd also say the odds of a significant housing crash are low. Even with a healthy housing market and economy, expectations are that the Fed will be very slow in raising interest rates. Most economists predict very low interest rates for the medium to long-term (look at the 10-year treasury bond yield for example). Plus you plan to move within seven years. And I don't see why being inside Boston (a city with tons of high income renters) would make it a bad investment property (low returns maybe, but safe).

Basically I think you're worrying WAY too much.

With that said, interest rates have come down quite a bit the past year and a half. With a good credit score, you might be looking at 2.75% for 15-year fixed and 3.50% for 30-year fixed, so that might be another option to calm your nerves especially if you can get a no cost refinance.

moof

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Re: Monetary policy / ARM mortgage
« Reply #5 on: October 21, 2016, 03:11:40 PM »
30 year loans have been around 3.5-4% for a while, which is all but free money.  You got slightly better than that, but have now put a potential time bomb in 5.5 years.  But the odds of interests rates going down in any substantial way is much lower than the odds of rates going up.

If interest rates go up you might not be able to unload the house for what you still owe, as higher rates make the same housing budget buy less loan value.  You might be stuck with an underwater house and ballooning payments.

In my opinion if you plan on dumping the house soon, you should have rented instead.

« Last Edit: October 21, 2016, 03:13:46 PM by moof »

Catbert

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Re: Monetary policy / ARM mortgage
« Reply #6 on: October 21, 2016, 03:35:12 PM »
Unless your loan is very unusual it can't jump from 3.25% to 8.25% all at once.  Generally they are adjusted once a year after the 7 years and can only jump 1% at a time.   Does that  you help you feel better?

You're just feeling what any homeowner feels:  did I make the right decision? did I buy at the right time? will I be able to sell at the right time? did I pay the right price? did I pick the right neighborhood? etc, etc.       


TrMama

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Re: Monetary policy / ARM mortgage
« Reply #7 on: October 21, 2016, 03:44:53 PM »
Or is there another reason I should change to a fixed rate before rates possibly go up later this year?


Forgive me for being a dumb Canadian, but we basically only have ARMs here. There's no such thing as a 30 year mortgage here, so I'm pretty familiar with your angst.

The only reason you should switch to a fixed rate mortgage is so you can sleep at night. Otherwise, you just keep paying the ARM at the cheap rate and come to terms with the fact that you'll have to refi at the end of the term to whatever the current rate is.

If you're concerned about not being able to afford the payment at a higher rate, then pay extra against the principle to ensure you'll always be able to meet the monthly payment.

Monetary policy is totally outside of your control. Just focus on the things you do have control over.

Jack

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Re: Monetary policy / ARM mortgage
« Reply #8 on: October 21, 2016, 03:46:36 PM »
And I don't see why being inside Boston (a city with tons of high income renters) would make it a bad investment property (low returns maybe, but safe).

Maybe rent control or excessively tenant-friendly rules or something?

cube.37

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Re: Monetary policy / ARM mortgage
« Reply #9 on: October 24, 2016, 03:39:18 PM »
Thanks everyone for taking the time to respond. I just really need to stop worrying and second-guessing things like this.

And I don't see why being inside Boston (a city with tons of high income renters) would make it a bad investment property (low returns maybe, but safe).

Maybe rent control or excessively tenant-friendly rules or something?

Usually low returns. Like having a rental in new york, you can find a good rental, but have to look much harder. Our building in particular isn't a great investment property - the top floor costed $600k and is renting for about $3400. With PITI of at least 3k (at 20% down), and just taking into account 1/12 vacancy, it can barely cashflow. I can't see how it would cashflow with everything else into consideration. AND he's using a property manager! Our unit is cheaper but numbers would be proportional. Some great homes make horrible rentals.

Goldielocks

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Re: Monetary policy / ARM mortgage
« Reply #10 on: October 24, 2016, 04:54:10 PM »
If you decide to not sell your place and need to continue with your ARM....  the following steps typically occur:

1)  Depending if your bought down points or have a discounted rate, you may or may not have a step increase in your rate at the end of your 7 years.

2)  Interest rates may increase, (Based on fed rate) but are unlikely to increase more than 0.5% in a year.  1% at the outside.


If based on the above 2 conditions, you determine that you can't afford your monthly payments:

A)  Start shopping 3 months early to refinance your mortage.  Another ARM is fine if you like.
B)  Refinance can include the following options, if it increases:
-->  Longer Amortization -- to lower monthly payments
-->  Higher monthly payments
-->  Put more money down to increase Loan to value.

Obviously there are some problems at this point, namely, if you no longer have income to cover the loan, or if your equity ratio falls into the mortgage insurance zone, or if you have to pay a lot of broker / mortgage fees up front.

The good news is that if you did not go aggressively on your mortgage financing in the first place, and have income, you should have no trouble refinancing after 7 years, as your increase equity tends to allow more flexible options for income and monthly payments.

Note that home prices rarely decline much.  Usually prices stay with 5% of your purchase price for many years (flat), rather than fall 10% or more.   So that 7 years of payments helps building in extra equity to buffer small drops. 

As another poster stated, 5 year ARMS are the normal mode for Canadian housing, (as the banks carry their own paper, so want options to match GIC rates more often), and it has been quite rare for someone to "lose a home" during the 5 year refinancing period,  especially if you put down 10% or more in the first place.   

If rates increase a lot, then people just refinance another 25 year or 30 year loan, instead of dropping it by 5 years each time...  or their income has increased to cover it ok.

fishnfool

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Re: Monetary policy / ARM mortgage
« Reply #11 on: October 24, 2016, 06:37:04 PM »
I also did a 7 year ARM a few years ago knowing we plan on sell before that. From what I've heard we won't see a crash like the previous one, more of a adjustment and slower growth when the rates start rising.

But worst comes to worse I could afford a few years of higher payments if I have to wsit for another housing recovery. But I really don't lose any sleep over it.